Blain’s Morning Porridge – November 12th 2019

Blain’s Morning Porridge  – November 12th 2019

“He knows nothing, and thinks he knows everything. It points clearly to a political career. ”

November 12th

Slight change in the Porridge distribution this morning. From now on it will be arriving as a link to the website. Please let me know if you have any problems with this format. 

UK Elections and Gilts. 

I probably don’t need to say anything about Labour or Tory spending plans re the current UK election. You just need to listen to the various spokespersons from both parties – and then figure it out for yourself. Watching most politicians talk about debt is a painful thing – and that’s not surprising. Most folk know very little about bond markets. We like to keep it that way. The less they know, the better the population will sleep soundly at night….

Relax and don’t worry. The bottom line is the UK Debt Management Office is probably the most professional bond issuer on the planet.  The Treasury is smart – they will say “Yes, Minster” and make it not happen. Governments can raise as much money as any government wants – the issue will be the price. If the government plan is credible, the price of that debt will remain low. If its stab-in-the-dark-guesstimate-maths – of the kind promoted by certain politicians in car-crash interviews – the plans won’t be credible and the yield on UK government gilts will soar – creating all kinds of issues for sterling, jobs and growth which are unlikely to be positive.

Since a key battleground in this election will be “who can spend the most the fastest”, let me offer aspiring UK politicians hoping to hold the purse strings after Dec 12th some advice.

Here is the Blain primer for Politicians talking about Debt:

1) It’s all about credibility. If you are credible, you will be able to raise money at the best price.

2) Best way to build credibility is to at least know something about what you are taking about. If you don’t – Shut the **** up.

3) Enhance credibility by listening to the questions about spending and answer clearly and honestly. It is better to present proper plans on achieving proper economic goals (like infrastructure, training, education, renewables, etc), rather than screaming about a £30 bln unscoped spending binge plucked out the air to meet a vague policy goal canvassers have identified as high on voter priority lists.

4) If you have to bluff – build credibility by explaining one thing well rather than lots of things badly.

5) Don’t fluff or make it up – your credibility will be ripped to shreds and can’t be stitched up again.

6) Don’t say we have to spend billions on plan x. Credibility will be enhanced if you explain what we need to spend it on, and how you are going to do it.

7) Remember it is all about credibility. And credibility is critical. Don’t forget its about credibility.

I am available at a very reasonable price to coach candidates of either party on how not to come across as complete numpties in this debt-based election. (Liberals will charged triple rates because I’m sure they will tell me they know it already – while conclusively demonstrating they don’t.)

Bubbles in the debt markets?

I’m intrigued by recent moves in CLOs – Collateralised Loan Obligations. They have been one of the strongest performing sectors of the bond markets for many years. Smart investors realised pooled corporate credit investments spread the risk across a wide range of borrowers, and following the 2008 Global Financial Crisis there were surprisingly few corporate defaults. In fact, as rates tumbled lower investment grade and junk debt performed strongly – making CLOs even more attractive. CLOs are now a $750 bln global market.

But the CLO sausage factory needs constantly fed with new debt to keep churning out new product.. Therein lies danger…

Most of the loans making up CLOs are junk leveraged loans – the AAA tranches get paid the interest and principal first and face the lowest risk, while profits go to the CLO equity holders. The theory is simple – although a few loans might go bust in a pool, the others will cover the losses. Have you heard that thinking before? If you are thinking sub-prime.. give yourself a pat on the back.

Suddenly there a host of doomsters warning of imminent crisis in CLOs. Bloomberg says Norinchuckin Bank has exited a large part of its CLO book following new financial regulations and greater regulator scrutiny. The Bank of Japan warned its bank charges about ratings and prices of CLOs being vulnerable to substantial falls if market conditions change. Japanese banks are said to hold 15% of the CLO market. Norinchuckin has been one of the largest players in the market – some estimates say it accounts for nearly 10% of the total market!

There has been plenty of anecdotal evidence the quality of loans made to heavily indebted sub-investment grade companies has fallen.  The private equity owners of companies that issue the bulk of the highly leverage loans that make up CLOs have been using ultra-low interest rates to lever up companies to higher and higher levels, spurred on by demand for more and more CLOS! They’ve also been cutting covenant protections – making it simpler to finance more debt, effectively raising the credit risk of each loan, and leaving the end investors even more exposed.

A number of investors have exited the market, concerned that highly levered, covenant lite issuers could see a far greater default rate than before in the event interest rates rise. They’re looking at some deals at the “Whoosh” end of the CLO market where the managers are willing to take greater risks as reminiscent of the Sub-Prime Mortgage crisis where Residential Mortgage Back bonds comprised loans to individuals who were very unlikely to ever be able to pay them back.

On the other hand, a great article in WSJ this morningquotes on CLO buyer as seeing recent price slides as: “we’ve been increasing our double-B allocation in the last month”, spotting the recent sell off in CLO prices may be an opportunity.

It’s a market we’ll be watching in coming months.

A blast from the past… 

Great article in the FT this morning about a new convertible deal for the Shanghai Pudong Development Bank. The deal attracted a $1 trillion book for the $7 bln deal. Wowser! Is that a record I wonder?

As the article points out, Chinese convertibles are somewhat different to occidental converts.  They rather remind me of the glory days of the Japanese Equity Warrants market back in the 1980s. Ah, these were the days. How we played in stuff in we barely understood.  Japanese companies we’d never ever heard of being the hot deal of the day, rumours of back handers to ensure allocations and all kinds of shady goings on. These were the days….

Much the same thing seems to be going on in Chinese convertibles – investors know they are hot so they put in vastly inflated orders in the hope they get some bonds. The future is a mobius strip loop of endless repeat moments.

5 things to read today:

FT – The wealth tax plan worrying US billionaires

WSJ – ESG Funds Enjoy Record Inflows, Still Back Big Oil and Gas

WSJ – Hong Kong’s Gravit-Defying Property Market Can’t Walk on Air Forever

Thunderer – China’s Singles Day nets record £30 bln

Bloomberg – Why the Repo Markets Went Crazy, and What it Meant

Out of time.. and back to the day job…

Bill Blain

Shard Capital