Investor Insights

July 2019 Investor Report

Published: August 31, 2019Updated: September 30, 2019

Following dovish statements from the world’s largest central banks, “risk-on” assets continued their upward growth in July. The S&P 500, Dow Jones Industrial Average, and Nasdaq all realized over two percent in total returns. Historically, negatively correlated assets like bonds and precious metals also enjoyed positive returns.

As in the past, financial markets continue to take their lead from monetary policy leaders. As guidance from leadership continues to promote interest rate cuts in the near-term future, a slowing supply of new bonds are creating market movements in advance of these cuts. Both sovereign and corporate borrowers are experiencing an acceleration in the amount of negative yielding bonds. Countries like Japan, France, Germany, and others all had negative yielding 10-year bonds. In the corporate space, there are more than 12 European, high-yield (junk bond) rated companies are producing negative interest rates. At present, the amount of outstanding debt with negative yields is over $13 trillion dollars.

Investable capital is now sufficiently abundant that new bond issuers are finding the markets very welcoming. Last week, PepsiCo, the makers of the popular soft drink Pepsi and owners of brands like Doritos and Aquafina, came to the market, with a $2 Billion offering. After 48 hours of solicitation, the bond deal was subscribed 3x over. The terms that PepsiCo received were favorable; The company was able to be achieve the tightest spreads of the year on all new issuances on their 10- and 30- year new issuances. The “spread” is the difference between coupon interest rate and the comparable US Treasury bond for the same time period. A tight spread reflects interest rates are which closer (lower, cheaper) to the benchmark (in this case US Treasury Bonds). When spreads are “wide”, interest rates are farther from (higher, more expensive) the benchmark. New issuance of bonds has fallen about eight percent year-over-year. Adding to this dynamic, investors have more cash than ever before, pushing rates ever lower. Still, the decrease in bond issuances is the result of unusually high corporate debt levels compared to historic norms. For these companies, issuing more debt would pose greater risk to becoming downgraded and possibly not ownable by certain financial firms. Moreover, political leaders have exerted pressure on companies to repatriate cash onshore, possibly decreasing their need for debt. Adding to this, legislation passed by Congress in the 2017 tax bill eroded some tax shields that businesses would use when issuing new debt. Finally, central banks around the world have made their respective currencies so cheap that businesses based in the US could go there to raise money (indicated by a surge of “Yankee” issuances).

Please review the following updates from some of the existing positions that we manage:

Aspen Insurance Series C Preferred— (AHL-C): On July 23rd, Credit Rating agency Moody’s gave Aspen Insurance’s Long-Term Issuer Rating a ‘Baa1’ rating. It is important to remember that an issuer credit rating is different than the credit ratings for the individual asset classes (like senior unsecured bonds, preferred stock, etc). On May 30th, Moody’s upgraded our Series C Preferred Stock to Baa3.

Medley Capital Corporation Bonds— (MCX and MCV): Continuing from our brief in June about the situation regarding Medley Capital, we closed out of our bond positions in early July. The decision to the sell bonds before the resolution looks to be the correct one; On July 22nd, the company announced a consent agreement with Israeli bondholders to accelerate their bond repayment at a materially higher interest rate. Fortunately, the bonds currently are situated a few percentage points below the position when we sold our position.

Oppenheimer Holdings 1st Lien Debt due July 1, 2022— (CUSIP: 683797AD6): The financial services company announced that they are going to redeem 25 percent of the outstanding first lien paper that we own. The company reported second quarter earnings that showed both top- and bottom-line growth. The credit quality has improved since our initial investment a couple years ago and we are disappointed to be losing a portion of our position. As discussed earlier, these developments are becoming commonplace with interest rates becoming abnormally low again. The tentative redemption date will be August 25th and will be performed by the bondholder’s Trustee (the firm that represents all bondholders together as one class) at random.  The redemption will involve a call premium, so the lienholders whose paper will get called will be paid $1,033.75 per bond.

Customer’s Bancorp Series F Preferred Stock— (CUBI-F): On July 26th, the company reported market pleasing second quarter earnings (up around five percent on the day of earnings). Our preferred stock continues to generate a tax advantaged (QDI) six percent coupon. We are still anticipating a redemption when first eligible in December of 2021. The spread (or premium) of 476 basis points in the floating rate is high for an investment grade issuer. We are encouraged by this quarter’s report after several weak quarters. As always, we appreciate the trust you have placed in us with your investments. Please feel free to reach out to us with any questions or comments.