Monday Musings: July 20, 2020

Jul 20, 2020

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Public Trust Credit Team

As stimulus talks continue, corporations look to tax credits to generate liquidity

Ideas for the next round of fiscal stimulus have been floating around, largely split across the aisle on whether it should go to businesses or individuals, but some companies are looking for a less traditional stimulus in the form of tax credit cash-outs. Many corporations have built up large tax credits through research and development credit, renewable energy credit, and affordable housing credit. Because of the 2017 Tax Cuts and Jobs Act, corporations with these credits have to continually roll them over due to their taxable income not being large enough. The companies that have these credits span across industries including autos, banks, and energy, and some of these credits are sizable. Allowing companies to cash out these credits ahead of schedule would help them generate substantial liquidity (over $1 billion in some cases) without tapping the debt markets. From a credit perspective, a tax credit cash-out would broadly be positive, but it remains to be seen if the idea will receive bipartisan support.  

U.S. banks Q2 2020 earnings highlights

Bank earnings are now well underway. As expected, market-related businesses and investment banking results were particularly strong this quarter, benefiting the largest players and helping counterbalance weaknesses in the consumer lending businesses that resulted from the shutdowns. Unsurprisingly, the low interest rate environment added pressure on net interest margins but supported mortgage origination fees. A key focus this quarter was loan loss provisions, particularly as the large U.S. banks must now adhere to the Current Expected Credit Losses (CECL) methodology that aims to capture expected losses over the life of loans. As a result, banks were forced to set aside billions of dollars to keep themselves safe (money that cannot be distributed to shareholders or reinvested in the business). 
 
Asset quality remains solid at this time thanks to the unprecedented government support and deferrals that have taken place but is likely to worsen starting in the second half of the year (which is why banks recorded such large provisions over the past two quarters). Capital and liquidity remain solid for the large players, a strong credit positive. A lot of uncertainty remains on the horizon, particularly around the pace of economic recovery. Still, the consensus view remains that provisions for loan losses peaked in Q2 and that the bottom line should generally improve going forward.

Chevron Corp. announces planned acquisition of Noble Energy Inc. in an all-stock deal for approximately $5 billion

Supermajor oil giant Chevron Corp. announced this morning that the company had reached an agreement to acquire Houston-based independent oil and gas producer Noble Energy in a transaction valued at approximately $13 billion including debt. This is the industry’s largest transaction since Occidental Petroleum Corp. acquired Anadarko Petroleum for around $37 billion in 2019 as well as the first major transaction since the oil market saw a precipitous destruction in demand caused by the onset of COVID-19 paired with the short-lived price war between Saudi Arabia and Russia. This may be a sign of future consolidation within the industry, as larger, more diversified, and financially sound integrated oil and gas companies make possible moves to acquire assets for future growth while valuations remain depressed. Noble’s portfolio includes assets in the Mediterranean as well as acreage in the Permian Basin and the Colorado Denver-Julesburg Basin. Presently, Chevron anticipates approximately $300 million in run-rate cost synergies from the transaction, and the deal is expected to increase the company’s total reserves by close to 20%. The acquisition of Noble represents approximately 7.2% of Chevron’s enterprise value.
 
Additionally, the U.S. Energy Information Administration (EIA) released its July Short-Term Energy Outlook this week, anticipating that U.S. consumption of petroleum will continue to see an uptick in the second half of 2020, but levels will remain below the 2019 average until August 2021. With economies reopening and support from OPEC+ production cuts, the EIA is projecting Brent Crude to reach an average of $41 per barrel throughout the remainder of 2020 and rise to an average of $50 per barrel in 2021.
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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