ft markets 29'11
Tail Risk
Joe RennisonIf the cheap money era implodes, triple B debt could be where the first cracks formA topsy-turvy thesis is gaining traction among debt investors, with some fund managers arguing that the supposed safety of buying the highest-rated US corporate bonds is an illusion. Instead, the argument goes, buying much-maligned BBB-rated bonds — which sit just above the threshold of junk — is a better, possibly even safer, bet.
Triple B debt is typically seen as a potential breaking point in a long-overdue reckoning in the corporate debt markets. If the cheap money era implodes, this could be where the first cracks form.
But the case in their favour begins with big companies like AT&T, Verizon, or most recently AbbVie, each of which has deliberately loaded up on cheap debt to fund large takeovers, taking a hit to their credit ratings in the process. AbbVie borrowed $30bn from investors this month to fund its takeover of rival pharmaceutical company Allergan. In response, rating agency S&P Global said it expected to lower AbbVie’s sole single A minus rating to triple B plus when the deal closes in the first quarter.
That doesn’t sound too positive but AbbVie, like others, is now committed to reducing its debt to maintain its investment-grade rating.
Investors say that over time, this represents a good bet. If the quality of the company improves so, too, should the value of its bonds.
In contrast, companies rated A or above still have room to go through the same punishment as AbbVie, if they decide to take advantage of low borrowing costs to fund acquisitions or buy back stock.
“BBBs get all the airplay but if you take a step back . . . people are probably underappreciating the risk of A-rated companies getting downgraded to BBB,” said Josh Lohmeier, head of North American investment grade credit at Aviva Investors.
Investors like Mr Lohmeier are nervous that they could find themselves paying up to buy debt right before a company is downgraded. One potential example highlighted by investors is tech company Oracle. In September, it said it would increase its efforts to buy back its own stock and signalled that it remained open to acquisitions — both of which could threaten its A rating. Investors also point to tech company 3M, which increased its stock buyback plans a year ago.
Instead, some favour betting on companies already committed to more prudent balance sheet management.
“You have a lot of very large BBBs that are trying to pay down debt. That has not changed,” said Hans Mikkelson, a credit strategist at Bank of America. “What has changed is the companies that have more capacity — like As and AAs — have added more debt. I would be concerned buying A and AAs. The risk is those bonds will get downgraded.”
It seems taking more risk might actually be less risky. joe.rennison@ft.com
Financials
Ruling on franc mortgages hits Polish banks
JAMES SHOTTER — WARSAW
Poland’s banking stocks and currency tumbled yesterday after the country’s top court issued an unfavourable ruling in a closely watched and potentially expensive dispute over foreign-exchange mortgages.
Polish banks have around 104bn zloty ($26bn) worth of mortgages tied to the Swiss franc on their books, which were issued in the years after the country joined the EU, and have since morphed into the biggest risk hanging over the sector.
Borrowers were initially drawn by the lower interest rates on foreign currency loans. But when the franc surged against the zloty during the financial crisis, and again in 2015, many found themselves facing higher repayments, and thousands went to court to challenge their contracts.
In a ruling on one such case, Poland’s supreme court said yesterday that the loans could be converted back into zloty without cancelling the contract. It added that the interest paid by borrowers would continue to depend on Swiss franc interest rates, which are considerably lower than the zloty equivalent.
The ruling only applies to one case. But investors fret that the ruling — the first since the EU’s top court delivered its own landmark ruling last month on how to deal with such mortgages — could set the tone for other cases, and require Polish banks to reimburse tens of billions of zlotys to customers.
Bank Millennium — owned by Portugal’s BCP — fell almost 4 cent on the news, while Santander Polska dropped 3 per cent and Poland’s biggest bank PKO BP slid 2.9 per cent. The Polish currency weakened to its lowest level against the euro since the start of October.
The Polish banking association ZBP estimated earlier this year that in the worst-case scenario, the sector could take a 60bn zloty hit, albeit spread over several years.
Markets Insight
Magic money tree bears sour fruit for bondholders
Karen Ward
The magic money tree is in full bloom. The image has been commonly used by Conservative politicians in the UK to describe how their Labour rivals will fund fiscal policies. But now the major parties are falling over each other to announce generous spending packages for the National Health Service, schools, the police, and infrastructure projects.
Is it because austerity succeeded and the nation’s finances are back in good health? Hardly. The government has managed to stabilise the level of debt as a percentage of gross domestic product by reducing the annual deficit. But the trajectory for government debt looks bleak given the fiscal demands of an ageing population.
Why are even Conservative politicians suddenly relaxed about the level of debt? In a speech, chancellor Sajid Javid gave us the answer when he said: “With interest rates where they are today, it makes sense to borrow and spend the money.”
With higher debt not accompanied by punishingly high interest rates, the temptation to borrow more is too great.
These low interest rates are thanks in large part to the Bank of England and its peers. Almost as fast as the Debt Management Office has been issuing debt, the Bank of England has been buying it. The £600bn of government bonds bought under the BoE’s asset purchase programme amounts to about 38 per cent of the gilt issuance over the period. The ECB has absorbed about a third of Bunds issued since 2015.
This looks like a permanent gift from the central banks. The Fed tried for a while to shrink its balance sheet but has given up. The BoE never tried and the ECB is still buying bonds. If inflation remains absent, this would suggest there is still a large amount of spare capacity in these economies and a combined push from both monetary and fiscal policy is economically sensible. Governments can keep spending, debt can keep rising, the central bank can keep interest rates low.
But if there is no spare capacity in the economy, inflation will show up and we have a problem. The fiscal expansion we are looking at is sizeable. The chancellor’s spending review delivered in September already announced a £14bn increase in the 2021 fiscal year.
This is a 4.1 per cent real increase in day-to-day government spending, and is more than half a per cent of GDP.
On top of this, the Conservative manifesto commits to an additional £20bn per year for infrastructure. The Labour manifesto boasts even higher departmental spending across all departments and an increase by as much as £55bn per year for infrastructure.
Some of this additional spending will go towards public sector recruitment and pay. Both major parties also have ambitious plans for the national living wage. The Labour party plans to increase it immediately from £8.21 to £10. The Conservative party plans to raise it to £10.50 by 2024.
About 7 per cent of workers are on the “national living wage”, but such an increase would capture a much broader section of the workforce, perhaps as much as a quarter of total private employment.
Yet there is little talk of the inflationary implications. Like Mark Carney, BoE governor, perhaps the market is preoccupied with external risks.
In a speech entitled “Sea change”, he argued that the risks facing the UK economy had shifted decisively to the downside due to global factors.
I agree with Mr Carney that a sea change is coming, but I am looking at a different ocean. Put simply, it was hard for the BoE to encourage inflation when about a fifth of the workforce was on a pay freeze. On the parties’ suggested trajectory, they are not.
Assuming that a no-deal Brexit is off the table, I struggle to see how the economy will absorb these spending policies without some acceleration in inflation in the coming years. If so, this will prove disappointing for those who have bought gilts at recent nominal lows.
A repricing of short-term policy rates could see 10-year bond yields move back above 1 per cent. If domestic pressures coincide with a resolution of global tension, then the move could be more significant than that. It would not be bad for the full range of sterling markets, since higher pay should feed into higher consumer spending, which in turn could increase the appeal of domestically focused UK stocks.
No one will be more disappointed by a hawkish shift at the BoE than the government. The next chancellor would do well to remember that what the bank giveth, it can take away.
It may not after all prove so cheap to fund all this additional spending that the electorate has been promised.
Karen Ward is chief market strategist for Emea at JPMorgan Asset Management
I agree with Mark Carney that a sea change is coming but I am looking at a different ocean
Asset management. Research reform
Investment analyst shake-up champions data mining
Banks battle to stay relevant with fresh information sets, charticles and podcasts
ROBIN WIGGLESWORTH
Dealmakers, traders and globetrotting executives are the public face of the modern investment bank but, for many clients in fund management, the key point of contact is with banks’ less glamorous ranks of analysts.
That investment research business is going through a profound reshaping. New investing strategies, regulations, commercial pressures and technology are forcing a rethink of what analysts do, how they do it, and the ways their work is distributed to clients.
“Everything is changing, so investment research has to change as well,” said Lou Pirenc, global head of research data at investment bank Morgan Stanley.
The immediate impetus is Europe’s Mifid II regulations, which forced asset managers in the region to pay directly for research rather than subsidising it by routing trading orders through banks.
Given the practical difficulty of divorcing European from global operations, many asset managers have adopted this unbundling of research fees as practice everywhere.
Having to pay directly for analysis has triggered a rethink on how much research they consume, which has washed over research departments at investment banks like a tsunami — including in the US.
“Not only has unbundling impacted US money managers, it is in the process of changing the whole nature of investment research,” Tabb Group, a markets consultancy, said in a report.
Other, broader trends are having as big an impact on research.
Asset management has evolved over the past decade, with the rise of cheap, passive index-tracking funds and computer-driven strategies, and investment groups that primarily work in private markets rather than public ones.
That is a challenge for analysts that have historically focused on producing stock tips, economic research and fixed income strategy for old-fashioned investment managers.
Bank of America has set up a dedicated ETF strategy team to meet the demand.
“The rise of passive investing in particular has changed what clients want, and we need to respond to that,” said Candace Browning, head of research at Bank of America Merrill Lynch.
Analysts are increasingly turning to data science to cater to computer-driven investors, who seek to meld it with traditional fundamental investing, as well as a broader group of corporate clients.
Analysts sift through non-traditional information such as satellite imagery and credit card data, or use artificial intelligence techniques such as machine learning and natural language processing to glean fresh insights from traditional sources such as economic data and earnings-call transcripts.
“If all you’re doing is traditional fundamental analysis, it’s not enough any more,” said Joyce Chang, chair of research at JPMorgan.
Almost every bank is exploring how newer technology can enhance their analysis or even become a separate business line.
An example is UBS’s Evidence Lab, which last year was split off from its research department as a unit that collects, cleans and sells data to clients independent of its primary research offering.
“It’s a significant moment,” said the head of data at one major asset manager. “It’s the start of a profound change of what the sellside is.”
Evidence Lab is far from the only such effort in the industry, though operating as a separate business is unusual.
It was itself initially modelled on Morgan Stanley’s AlphaWise, a unit of about 100 data scientists, coders and analysts.
“Analysis used to be very opinion-oriented,” said Mr Pirenc. “Now everyone wants the raw info. It’s about analysing it better.”
For now, verbose reports remain the bread and butter of an investment bank analyst. But the form of the content is evolving.
These days, reports are often shorter and punchier, and research can come in the form of videos, charticles, live events and podcasts — and all are also distributed through social media and messaging apps.
“We have to adapt to the times,” said Dan Dowd, head of research at UBS. “I want to deliver content to clients in the way our clients want to consume it.”
Distribution is increasingly focused on pulling readers in rather than pushing content out. Rather than emailing research and praying it gets opened, many banks have built up personalisable research portals.
More content is now made public. The websites of most big investment banks look more like those of think-tanks.
Some money managers will still privately question the value of analysts, arguing that many of the best have migrated from banks to investment managers and that the remaining ones are overworked and prone to groupthink.
But questions over the worth of analysts are nothing new.
“Is Wall Street research useless?” the magazine Institutional Investor asked in the late 1960s. Yet over the years, asset managers have continued to spend their time — their most valuable resource — poring over the research produced by investment banks.
“The evolution of capital markets has put investment research departments in a tricky position,” Ms Browning said. “The industry has changed dramatically in how it’s done and distributed. But what has not changed is the fundamental job: coming up with great ideas.”
‘It’s a significant moment, the start of a profound change of what the sellside is’
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