Monday Musings: March 29, 2021

Mar 29, 2021

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Public Trust Credit Team
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Investment banks warn of substantial losses related to Archegos Capital Management fund liquidation

Shares in Credit Suisse and Nomura Holdings are sharply trading down this morning as the large investment banking groups warned they could face upwards of millions in losses linked to the collapse of hedge fund Archegos Capital Management (ACM). Losses surfacing at ACM over the past several days have prompted the liquidation of positions valued at approximately $30 billion, and the U.S.-based hedge fund’s default on margin calls made with Credit Suisse and Nomura could result in billions of losses as the investment banks go through the process of closing the margin positions. According to an article in the Wall Street Journal, Credit Suisse stated that it is still too early to quantify the impact of the margin call default but that losses could be “highly significant and material” to first quarter results. Credit Suisse and Nomura are not the only banking groups to be impacted by the fund sell off; Morgan Stanley, Goldman Sachs, and Deutsche Bank have also been linked to ACM as the banks served as prime brokers to the hedge fund and were involved in unloading large trade blocks tied to ACM late last week, most notably involving the media companies ViacomCBS and Discovery along with a number of Chinese technology stocks. It appears that ACM’s fund allocation was heavily concentrated to a number of high beta stocks, and there are no signs at present to suggest the hedge fund’s downfall poses any serious systemic risk to the financial system. So far, the recent sell off in these companies has not trickled down to the broader market with the S&P 500 broadly unchanged since Friday’s close.

Low rates lead to the rare “re-leveraging” trade

When rates are extremely low, the cost of debt becomes so cheap that there isn’t a meaningful advantage to being ‘A’ rated or higher for most companies, leading them to adjust their capital mix and “re-leverage” by issuing debt to fund M&A and shareholder returns at the expense of their credit rating. This phenomenon was on full display last week with the two-notch downgrade of Oracle Corporation after the company spent the last year raising debt to fund its aggressive share repurchase program. Ultra-low rates make the calculus of choosing to issue debt much easier; when the market is not rewarding highly rated companies with much lower rates, some companies choose to re-lever their balance sheet and take the rating hit. Because of the environment created by low rates and the post-pandemic economy, we expect some issuers to willingly allow their ratings to fall, making a diligent credit research process all the more important.
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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