Night Of The Living Debts

What caught our eye this week was the emerging significance of the asset class usually confined to the back pages of the FT – debt.

A former boss of mine used to marvel at the typical information bias of editors and readers of the broadsheet version of the Financial Times (FT). Of the thirty-odd pages in the daily must-read for finance professionals, all bar the back two or three pages were devoted to equities. My boss’s point was that that the debt and currency markets were quantums bigger and ultimately far more influential than stock markets. I was reminded of this overnight as various market commentators and media outlets breathlessly gushed about yet another huge move in stock markets around the world.

For this writer, last night’s 1000 point upwards move by the Dow Jones share price index was almost irrelevant. What caught the eye was the emerging significance of the asset class usually confined to the back pages of the FT – debt. In a previous article, “Other People’s Money”  back in July 2019, we cautioned readers about business models, and even countries, overly dependent on the daily funding/kindness of strangers. Furthermore,  we specifically warned that “these companies struggle for survival when markets take fright and all providers suddenly decide they would rather hold onto their liquid funds until volatility recedes”.

Well, this is a “fright” moment for capital markets and that sucking sound you hear is not a gurgling Texan oil well but capital swiftly draining from riskier parts of the markets. Let’s start with oil, or rather shale oil. The dramatic escalation of production in Saudi Arabia and subsequent collapse in oil prices is threatening the survival of many US shale oil players who have borrowed via the high yield (junk) bond markets. More than two-thirds of these companies are now trading at distressed levels in junk bond portfolios. This is not good news for these oil companies or their bankers.

US banks will be watching high yield indices as nervously as they watched mortgage-backed securities (MBS) indices back in 2008. The mighty Bank of America has seen its share price crater by a third in less than three weeks. That’s worrying but not fatal. However, in Italy, a country now in total shut-down mode, one wonders how an already fragile national banking system will cope with a shock hit to funding flows. Recall that all banks and insurance company business models are dependent on other people’s money to carry out their daily operations. It can become very ugly if daily funders suddenly take fright. Just ask Robinhood.

Fintech has been receiving great press on these pages and elsewhere but it is not a one-way bet. A real crisis can expose weaker fintech platforms. Robinhood has had a number of trading outages in the past week which has frustrated users wishing to buy or sell shares on its investment platform. If this wasn’t worrying enough for its customers there have been reports that the company maxed out its $200 million credit line in February when market volatility first struck. The company has reassured the market that liquidity has been restored but this will hardly keep its army of 10 million users in “merry men” mood. Expect more news there.

Of course, the news is already full of stories on airlines struggling to keep empty fleets airborne. Note many airlines use other people’s money when they lease aircraft. This has been a rapidly growing sector of the debt securities market and Ireland is the global leader and IP capital of this funding model. We have written previously about our caution on leasing models predicated on airlines benefitting from a national “backstop” from governments. The rationale is that countries would be unwilling to restrict/shut off their airspace by defaulting on leasing debts. Let’s just say public health systems have just zoomed to the top of most government funding queues in the Covid-19 crisis and difficult choices may lie ahead. The potential impact of Covid-19 at a national level could cause defaults in sovereign debt markets too.

Lebanon has already defaulted on its bonds over the weekend. Turkey and Brazil worry lots of observers, and Japan had already experienced a GDP decline of 6% BEFORE Covid-19 struck. It’s early days yet but there is no doubt debt stories are migrating towards the front pages of the FT.  As always, when the funding tide goes out naked bad behaviour can reveal itself at the corporate level.

The hospital operator NMC Health is a blue-chip name in the FTSE 100 but it looks like investors will now be screaming blue murder. The company has kindly informed the market it has discovered it has an extra $2.7 billion of debt its board never even knew about! That more than doubles the debt burden of the company and probably ensures a fraud investigation. Meanwhile, Boeing has had a bad 12 months already but its bankers were happy last month to provide it with a $14 billion credit facility to assist it through production and delivery delays on its troubled 737 Max aircraft model. Those same loan syndicate banks might be a little bit queasy to hear Boeing plans to draw down on the entire $14 billion by Friday…

None of this is good for creditor confidence. Hence, our caution about companies’ dependent on other people’s money. Those kind people might just take fright when the back pages of the FT become the main story and naked corporate bodies wash up on the shore.

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