Monday Musings: October 19, 2020

Oct 19, 2020


Public Trust Credit Team
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U.S. corporations issued tons of debt this year but next year might be sparse

According to estimates from Bank of America, 2021 could see the lowest investment-grade corporate issuance since 2011 and the lowest net issuance since 2002. The COVID-19 global recession turned out to be prime for companies to both issue and refinance debt. Lower interest rates from the Fed allowed companies to refinance most of their debt loads and push their maturities out to the long end of the curve. Many corporations also took the opportunity to draw revolvers and issue debt to support their liquidity that they ended up not needing. BofA estimates that the industrials sector, which saw some of the highest 2020 issuances, is sitting on a $350 billion dry powder pile for liquidity events that never occurred. U.S. IG corporates still do not have much capacity to add debt as balance sheets were bloated pre-COVID; coupled with the issuance and refinancing this year, 2021 is shaping up to be a sparse year for the primary IG bond market.

Q3 2020 earnings season has arrived – highlights from last week’s U.S. bank earnings

Last week, a number of major U.S. banks reported Q3 earnings. For the most part, revenues continue to hold up well, particularly for banks with highly diversified business models. Capital market revenues remained solid although activity levels were not quite as extraordinary as what was witnessed in the second quarter. Mortgage banking remains a bright spot as customers continue to take advantage of low interest rates to refinance. Credit and debit card spending has also slowly been making a comeback in recent months following the lockdowns from earlier this year. The low interest rate environment, however, will continue to pressure net interest income and net interest margins for the foreseeable future.
Banks spent the first half of the year ramping up their loan loss reserves and appear to have reached adequate levels to deal with the current economic uncertainty. There is evidence that actual loan losses have been delayed until next year thanks to the unprecedented level of monetary and fiscal stimulus as well as the forbearance measures granted by banks this year. Additional stimulus, should it occur, would likely further reduce the through-the-cycle loss levels for the banking sector as a whole, potentially triggering larger reserve releases when the economic environment stabilizes.
Despite holding excess capital above their stressed capital buffer requirements, the largest banks are still not allowed to return capital to shareholders via share repurchases as the regulators are primarily focused on capital preservation during these uncertain times, a strong credit positive. Liquidity levels remain solid across the board thereby ensuring the smooth functioning of the banking sector. After bottoming out in Q2 2020, earnings have already started to rebound as most of the provisions for credit losses have already been recorded on the income statement during the first half of the year, a positive for profitability metrics.

ConocoPhillips plans to acquire Concho Resources Inc. for approximately $9.7 billion

Announced this morning, Houston-based ConocoPhillips will acquire Midland-based Concho Resources in an all-stock transaction worth about $9.7 billion, representing a roughly 15 percent premium from closing share prices on October 13. Concho Resources, one of the largest shale producers in the U.S., has significant assets in the Permian Basin of Texas and New Mexico. Collectively, the combined assets will help create a powerhouse driller within the shale-rich region. The acquisition comes on the heels of Chevron Corp’s completed $5 billion purchase of Noble Energy Inc. and the announcement of Devon Energy’s $2.6 billion planned acquisition of WPX Energy Inc., both all-stock transactions. Given the tumultuous year for the energy sector amid the COVID-19 pandemic, oil prices have mainly stabilized with Brent Crude and West Texas Intermediate trading in the low $40 per barrel range. Given this stabilization and the current economic environment, the market may see additional consolidation within the sector as well-positioned companies aim to add valuable assets to remain competitive with the ensuing global economic recovery.

China shows another quarter of strong growth, but is it enough to lift the world?

China reported 4.9% growth in the third quarter, an increase of 1.7% over the Q2 print but lower than most economists expected. China is likely to be the only large global economy to show growth this year as the country has seen benefits from fiscal stimulus centered around extending credit to companies and local governments as well as to keep manufacturing humming. We mused last week that net exports from China were improving and while this can be seen in the data, the effect this will have globally remains to be seen. As the world moves into recovery, the export picture in China will likely weaken as more countries ramp up their production, and household debt remains a major concern for the Chinese government. Due to the hot housing market and Chinese households having record amounts of debt, the Chinese economy likely does not have much room to run before the government steps in, potentially tempering the final benefit of China’s post-COVID-19 expansion on the global economy.
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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