Eyes Wide Shut
The Commodity Futures Trading Commission’s Monday complaint against the Binance digital exchange featured no shortage of notable assertions. Yet even with plenty of competition, the following excerpt referencing former chief compliance officer Samuel Lim manages to stand out (hat tip to the Twitter account Chairman Birb Bernanke):
Internally, Binance officers, employees, and agents have acknowledged that the Binance platform has facilitated potentially illegal activities. For example, in February 2019, after receiving information “regarding Hamas transactions” on Binance, Lim explained to a colleague that terrorists usually send “small sums” as “large sums constitute money laundering.” Lim’s colleague replied: “can barely buy an AK-47 with $600.” 
And with regard to certain Binance customers, including customers from Russia, Lim acknowledged in a February 2020 chat: “Like come on. They are here for crime.” Binance’s money laundering reporting officer agreed that “we see the bad, but we close 2 eyes.”
The Ride
It’s a changing of the guard at one gig-economy mainstay.
It’s a changing of the guard at one gig-economy mainstay.  Lyft, Inc. announced that both CEO Logan Green and president John Zimmer will step down in the coming weeks, with Amazon and Microsoft alum David Risher tapped to take over the top spot next month.   
Lyft’s incoming broom has his work cut out for him. Though the ride-share firm managed to post $4.1 billion in full-year 2022 revenues, up 28% from the prior annum, red ink flowed at a still faster pace, with a $1.6 billion net loss for the year representing a 45% uptick. 
“The macroeconomy is tough . . . [and] the competitive environment is tough. We have a very aggressive – very aggressive – competitor” Risher emphasized. Industry leader Uber Technologies, Inc. has indeed made hay during the pandemic, grabbing a dominant 74% share of U.S. ride hail business according to market research firm YipitData, compared to 62% in early 2020, with Lyft’s market share ebbing commensurately over that stretch.  
While Lyft shuffles the management ranks, the frontrunner continues to expand its reach.  The Financial Times reports that privately held grocery delivery firm Gopuff has outsourced more than 4% of its domestic business to Uber couriers, with the two firms discussing a further increase to that tie-up. Gopuff, which achieved a $15 billion valuation in summer 2021 and has raised nearly $5 billion from investors including debt, has since conducted multiple rounds of layoffs and shuttered 76 warehouses, as revenues declined by 17% in January from a year ago per YipitData. Those retrenchments, in turn, have reportedly crimped the company’s supply of delivery drivers, leading to that outsourcing move. 
Might Uber’s long and winding ride towards profitability be approaching the homestretch? The firm generated a $1.8 billion operating loss during 2022, compared to a $3.8 billion shortfall in the prior period (net income was skewed by large swings in minority equity investments in both years), as revenues jumped 82.6% to $31.9 billion. Aggressive fare hikes have helped steer Uber closer to the promised land, as its average U.S. rideshare cost 43% more in September than those three years earlier according to YipitData, towering over the cumulative 16.1 % increase in CPI over that stretch.  
Though Uber has struggled as a public company, with shares off 33% from its May 2019 IPO price compared to a 47% return for the S&P 500 over that stretch, the firm’s legion of Wall Street admirers still expects big things. The 48 analysts tracked by Bloomberg (all but six of whom rate shares “buy”) collectively expect a 60% rally over the next 12 months per aggregate price targets, while penciling in $2.5 billion in adjusted net income for 2024. Uber, which lost $38 billion on an adjusted net income basis over the six years through 2022, sports a share price equivalent to 27.5 times the 2024 adjusted earnings per share guesstimate. 
As the largest ride-share firm draws closer to the black, a cornerstone of the food delivery business continues to spin its wheels. DoorDash, Inc. posted a $1.3 billion net loss last year, triple the $468 million shortfall seen in 2021, despite a 35% increase in revenues to $6.58 billion.  Shares are now off 42% from their December 2020 IPO price and 76% south of their fall 2021 peak, leaving DoorDash with a $23 billion market capitalization. 
Undaunted, the sell side anticipates that DoorDash will generate $222 million in net income this year, while the company detailed plans to launch a $750 million share buyback, after undertaking $400 million in repurchases during 2022.  
Yet investors face the prospect of ongoing dilution in addition to subpar operating performance, as Kynikos Associates founder James Chanos notes that the DASH share count grew 12% year-over-year in the fourth quarter despite those outlays. Meanwhile, DoorDash management isn’t exactly bulled up, as the C-suite has dumped $58.5 million of stock since the mid-February earnings announcement. 
Recap March 28
Stocks finished slightly lower as the post-Silicon Valley relief rally has given way to low-key conditions with three days left in the quarter, while Treasurys saw weakness at the short end, with the two-year yield rising eight basis points to 4.02% and the long bond unchanged at 3.77%.  WTI crude rose above $73 per barrel, gold rebounded to $1,973 an ounce and the VIX edged just below 20. 
- Philip Grant
Power Struggle
There’s your weaponization of social media.
There’s your weaponization of social media.  Expansion efforts by Norwegian armaments firm Nammo have stalled thanks to an energy-hungry neighbor, as the Financial Times reports that a new data center used primarily by Tik Tok is consuming the region’s available electricity. Local energy firm Elvira confirmed to the pink paper that its network is without spare capacity after contracting with the data center, as it allocates power on a first-come, first-served basis. 
Unsurprisingly, management at Nammo, which is attempting to ramp up its production in response to the war in Ukraine, is less-than thrilled by the roadblock. “We are concerned because we see our future growth is challenged by the storage of cat videos,” CEO Morten Brandtzæg quipped to the FT
Two Fast, Too Furious
“Risk free,” they said.
“Risk free,” they said.  Chaos continues to reign at the short end of the Treasury curve, as the two-year yield launched higher this morning, settling at 3.94% for an 18 basis points advance from Friday’s closing level.  As Chris Whittall, associate editor at International Financing Review, points out, that cornerstone interest rate has moved more than 20 basis points in either direction on nine separate trading days this year. For context, just five such one-day moves occurred during all of last year and zero during the annus horribilis of 2020.
All Politics is Local
Beggars can’t be choosers in China.
Beggars can’t be choosers in China. More than 60 real estate developers are turning to construction services projects to generate revenues, Bloomberg relays, underscoring the depth of the Middle Kingdom’s property doldrums. Such contracting-based work, “derided” by industry players a decade ago as China’s titanic real estate bubble billowed, “provides much smaller revenue than more [typical] sources.”
China’s property market pivot comes as profits at industrial firms sank by 22.9% from a year ago in January and February, data from the National Bureau of Statistics show. That compares to economist expectations of a 1.5% decline and a 4% year-over-year drop in 2022. Signs of persistent housing related weakness accompanied that dour figure, as furniture sales slumped by 23.5% from a year ago over the same two months. 
Today’s real estate hangover can be expected to linger, one industry player contends. Greenland Holdings Group chair Zhang Yuliang predicted at a weekend developer conference that new home sales this year will tumble another 17% after a 24% plunge in 2022. Yet, perhaps counterintuitively, land prices across 300 cities surveyed by the China Real Estate Information Corp. rose by 6% in 2022.  
Explaining that divergence: the exertions of regional authorities, who responded to the slowdown by increasing land purchases by local government financing vehicles (LGFVs), i.e. – selling land to themselves. LGFVs shelled out RMB 2.2 trillion to that purpose in 2022 according to Guangfa Securities, accounting for 65% of total purchases during the fourth quarter, compared to 43% in the last three months of 2021. 
Those outlays serve to support the Chinese economy at large, as elevated land prices underpin collateral backing bank lending, in turn bolstering government revenue through business taxes. “That explains why the real fear for Chinese officials isn’t a fall in the amount of land sold, but volatility in the price of land,” Bloomberg’s Tom Hancock wrote on Saturday. “When [prices] start to fall, that’s when the problems really begin.”
Local governments are already operating with precious little room for error, as direct debt stood at $5.1 trillion as of Dec. 31, double that from five years earlier and representing more than 120% of revenues in 2022, S&P Global Ratings found last month.  Importantly, those figures do not include LGFV’s, which owed $7.8 trillion at the end of 2021 (equivalent to nearly half of China’s nominal output) per data provider Wind.  
In a sign of rising stress, those local vehicles undertook a further $39.5 billion in cross-border borrowing last year. Pointing out that more than half of the 357 LGFVs which have issued cross-border bonds since 2014 have seen interest coverage ratios drop below one in each of the past three years, S&P concluded that “new financing would be required just to stay afloat even if they were to cut down on project investments.”
Meanwhile, China’s central government is throwing its own financing machine into overdrive. Net sovereign debt issuance stands at RMB 277 billion ($40 billion) in the quarter-to-date according to Bloomberg, the largest such tally going back to 1997. Gross issuance this year stands at RMB 2.1 trillion, up a cool 35% from last year’s pace. 
Recap March 27
Another early rally fizzled out as the S&P 500 finished just above unchanged while the Nasdaq 100 pulled back by 70 basis points, while Treasurys came under broad-based pressure with the long bond settling at 3.77% from 3.64% Friday. Gold fell to $1,958 an ounce, WTI crude jumped nearly 4% to $73 per barrel and the VIX fell below 21. 
- Philip Grant
Paint it Black
Is corporate malfeasance on the rise? The Wall Street Journal reports today that an indicator of potential earnings manipulation developed by Indiana University accounting professor Messod D. Beneish is registering at its most elevated levels since the late 1970s. The so-called M-Score, which tracks eight balance sheet and P&L metrics including changes in accounts receivable, depreciation expense and timing of accruals, signaled red flags at Enron and Wirecard prior to those firms becoming embroiled in accounting scandals. 
If past form holds, the M-Score’s ascent to 40-plus-year highs can be expected to usher in broader trouble. As the Journal notes, “the probability of manipulation usually rises rapidly in the quarters before the economy tips into recession.”  
Dot Dash
It’s a Wall Street whodunnit.
It’s a Wall Street whodunnit.  An unnamed central bank tapped the Federal Reserve’s Foreign and International Monetary Authorities Repo Facility for a record $60 billion during the week ended Wednesday. The pandemic-era facility – designed “primarily [to] be used only in times of unusual market stress” according to the Fed – requires that counterparties post U.S. Treasury collateral at an approximate 5% annual rate. 
As that sighting underscores, fraught financial conditions have taken hold in the wake of Silicon Valley Bank’s demise and the Credit Suisse fire sale. Witness the rise in Treasury market volatility, as measured by the ICE BofAML MOVE Index, to its most elevated levels since the financial crisis last week. Similarly, primary investment grade corporate bond markets went silent over the seven trading days through March 17, representing the first barren March week since 2013, according to PitchBook. High-grade firms issued $59.9 billion this month through Friday, the WSJ details, a fraction of the $179 billion average tally for March over the past five years.
Meanwhile, investors are increasingly confident that the Fed will soon abandon its efforts to clean up the inflationary mess in the name of financial stability. On Wednesday, the Federal Open Market Committee raised the Funds rate by 25 basis points to an effective 4.83%, with the monetary mandarins projecting a 5.1% benchmark at year-end via the “dot plot.” At the same time, interest rate futures price in a 4.49% funds rate by August, anticipating a reversal of this week’s move with room to spare, Alex Manzara, interest rate options trader at R.J. O’Brien, relays in a commentary today.   
What’s more, futures now anticipate a 3.6% rate by April of next year, down 125 basis points from current levels and well south the Fed’s median 4.25% projection at the end of 2024, presenting a clear opportunity for those who agree with that market outlook. “So,” Manzara writes, “if the local bank now has to offer certificates of deposit over 4% to cover vanished deposits that swooshed over to JPMorgan Chase or Bank of America, you might as well lock it in.”
Of course, a broad-based anticipation of lower overnight rates could further complicate a tricky financial backdrop. Citing data from EPFR Global, BofA strategist Michael Hartnett notes today that global net inflows into cash funds totaled $143 billion over the seven days through March 22, the highest weekly tally since the Covid panic. 
That flow of capital into Treasury bills, money market funds and other short-term yield instruments could put the crimps on stocks and bonds, which remain priced “too greed[ily] for rate cuts, [and] not fearful enough of recession,” in Hartnett’s view.  Once the anticipated asset price downdraft runs its course, “it’s secular leadership of inflationary cyclicals we will buy, not the old leadership of credit, private equity and large-cap tech,” the strategist concludes. 
Recap March 24
Stocks enjoyed a late lift as the S&P 500 managed to grind out a 1.3% gain for the week, while the tech-heavy Nasdaq 100 remains near its best levels in the year-to-date. Treasurys settled down a bit from their raucous recent price action, as two- and 30-year yields settled at 3.78% and 3.64%, respectively, while WTI crude slipped below $70 a barrel and gold pulled back to $1,979 per ounce. The VIX settled just south of 22. 
- Philip Grant
Jack and the Bean Stock
Second acts abound in the Middle Kingdom.
Second acts abound in the Middle Kingdom. Former Luckin Coffee CEO Jenny Qian has turned the page, establishing a rival low-priced outfit named Cotti, Bloomberg reports today, with plans to open 2,500 locations in China by year-end and 10,000 storefronts by 2025.  Opacity is the de facto corporate watchword, as Bloomberg relays that “Cotti’s corporate holdings are structured through offshore vehicles making it hard to identify its shareholders.”
Further coloring those ambitious plans: Luckin’s short, ignominious history as a public company, as the Nasdaq delisted its shares in June 2020 after the company admitted to overstating revenues by 60% in 2019, subsequently paying $180 million in fines to the Securities and Exchange Commission. 
Shares in Luckin, which nearly tripled over the eight months following its May 2019 IPO before collapsing during the accounting scandal, now change hands over the counter under new management, garnering a 136% gain over the past year to leave its market cap near $7 billion.  Earlier this month, the java purveyor reported fourth quarter revenues of RMB 3.7 billion ($555 million) up a cool 52% year-over-year, an impressive feat considering much of the country remained in Covid lockdown during that period.
Running on Empty
The wheels of commerce grind slowly.
The wheels of commerce grind slowly. Trucking firm Knight-Swift Transportation Holdings, Inc. (ticker: KNX) struck a deal Tuesday to buy peer U.S. Xpress Enterprises for $808 million, including debt. The opportunity was a “very compelling” one, KNX CEO David Jackson said, offering a “significant opportunity to improve earnings, gain customers and reach more professional drivers.” Knight-Swift’s truckload fleet will grow to 25,000 tractors and 93,000 trailers following the amalgamation, up 40% and 19%, respectively, to push its annual top-line towards $10 billion. 
Investors liked what they saw: KNX shares jumped 7% on the day of the announcement, even though the deal represented a hefty 310% premium to Xpress’s pre-announcement share price. Analysts at Bank of America predicted that the merger “should generate strong value,” given Knight’s “historic ability to improve returns.” There is certainly room for improvement, as Bloomberg’s Lee Klaskow noted that the target firm was unable to turn a profit last year, despite bumper-crop conditions across the industry.  
Yet that move towards industry consolidation comes as the virus-era salad days have given way to an increasingly forbidding backdrop. Fourth quarter shipment volumes declined 7.1% year-over-year and 4.6% sequentially to the lowest levels since the first three months of 2014, according to the U.S. Bank Freight Payment Index, as consumer spending habits shifted back towards services and away from goods in the wake of the pandemic. “The outlook remains challenging, but I think, as a group, the truckers were more optimistic on seeing a rebound as early as spring and as late as the back half of the year,” Cowen analyst Jason Seidl told Transport Topics last month. 
Yet more recent data is less than promising, as container imports at the ports of Los Angeles and Long Beach, the largest combined facility in the U.S., cratered 38% year-over-year in February, while intermodal shipping traffic fell 9.6% over the first 11 months of 2023 per the Association of American Railroads.  
A weakening price picture accompanies that slowdown in activity, as the Cass Truckload Linehaul Index, which tracks per-mile pricing data, fell 6% from a year earlier in February after a 5.6% decline in January. Prior to the start of this year, that metric had grown on an annual basis in each month dating back to late 2020. 
“Soft real retail sales trends and ongoing destocking remain the primary headwinds to freight volumes, and sharp import declines suggest this type of environment will persist for several more months,” Tim Denoyer, vice president and senior analyst for ACT Research, wrote last week. 
Meanwhile, the prospect of an un-bullish milestone looms large, as tender volumes within the truckload market (a measurement of electronic offers from shippers to truckload carriers for the transport of goods) teeters near their weakest since 2019, FreightWaves CEO Craig Fuller notes on Twitter today. 
At the same time, the share of rejected tender offers sits below 4% to approach the weakest levels on record, “as carriers take almost any load offered,” Fuller relays.  Then, too, the “abysmal” state of spot rates, which have retreated to $1.67 per mile from north of $3 in early 2022,  means that “carriers are likely losing money on a good portion of loads they haul in the spot market.”
See the Nov. 11 issue of Grant’s Interest Rate Observer for more on the adverse backdrop for truckers, along with a trio of ways to potentially profit from the industry downshift.
(Definitely Not a Bailout) Progress Report
Reserve Bank credit rose by $211 billion from a week ago, leaving interest bearing assets on the Fed balance sheet at $8.66 trillion.  That’s up $353 billion from the interim nadir logged on March 9 and back within $267 billion of the 2022 high-water mark, offsetting roughly two-thirds of the recent QT operation, notes Bianco Research eponym Jim Bianco.  
Recap March 23
Treasurys remained in spin cycle, as two-year yields darted lower by 20 basis points to 3.76% while the long bond settled at 3.66%, or 114 basis points below the yield on offer in six-month bills.  Stocks continued to shrug at that chaotic price action, as the S&P 500 finished just above unchanged and the Nasdaq 100 rose 1.2%, though each finished well off their best levels of the day. Gold ripped higher by 2.5% to the doorstep of $2,000 per ounce, WTI crude retreated below $70 a barrel and the VIX ticked towards 23.  
- Philip Grant
An Inconvenient Truth
“We haven’t slept since Sunday,”
“We haven’t slept since Sunday,” a Singapore-based banker tells the Financial Times. “People are absolutely gob smacked.” Spurring that agita: the complete writedown of Credit Suisse’s $17 billion of additional tier 1 (AT1) bonds in the wake of its weekend fire sale to UBS.   
The wipeout reverberates across the Far East, as Asian investors hold an estimated 17% of the notional $260 billion in global AT1 supply, alongside Wall Street A-listers Pimco, Invesco and Legg Mason. As the Pink Paper relays, the fact that common shareholders received $3.25 billion in the deal left some zeroed-out AT1 holders “stunned,” as the junior debt instruments were “generally believed to rank ahead of equity on the balance sheet.”
Yet as Bronte Capital founder and CIO John Hempton pointed out on Substack, a closer look at the legal documentation could have forestalled those sleepless nights. The 2013 prospectus for the 7.5% tier 1 capital perpetual notes includes the following: 
Furthermore, any write-down will be irrevocable, and, upon the occurrence of a write-down, holders will not. . . receive any shares or other participation rights in CSG or be entitled to any other participation in the upside potential of any equity or debt securities issued by CSG or any other member of the group. . . The write-down may occur even if existing preference shares, participation certificates and ordinary shares of CSG remain outstanding.
Valley Cats
Payments firm Stripe, Inc. raised upwards of $7 billion
Payments firm Stripe, Inc. raised upwards of $7 billion in a Series I funding round last week, the largest venture capital deal in U.S. history by PitchBook’s lights. The influx serves to keep a happy shop considering the frozen IPO market, helping cover tax liabilities related to expiring stock options among its 7,000 staffers. “Stripe does not need this capital to run its business,” the company emphasized.
Yet the cash infusion comes at a price, as Stripe achieved a $50 billion valuation in the transaction. That’s a near 50% discount to the $95 billion price tag logged in March 2021 and below the $55 billion illustrative valuation used in investor marketing documents, according to the Information. 
Stripe’s haircut underscores a grim state of play for the startup sphere and its backers, even before Silicon Valley Bank’s visit to Davy Jones’ locker. As CNBC documented last month, the industry faces the prospect of proliferating zombie venture funds, or those that are unable to raise money to undertake new investments, instead managing their existing holdings in something akin to an insurance company in run-off mode. VCs launched a record 274 funds last year, data from Dealroom show, up from 158 in 2019. 
Noting that those torrents of capital flowed into fancily priced assets at or near the bull market peak, Frank Demmler, professor at the Carnegie Mellon School of Business, told CNBC that “they then have a situation where their ability to make the type of returns that LPs want is close to nil. That’s when the zombie dynamic really comes into play.”  
Then there’s SoftBank Group Corp., i.e., the epitome of the cycle (Grant’s Interest Rate Observer, Dec. 15, 2017). Last month, SoftBank disclosed a $5.8 billion loss within its two Vision Funds over the quarter ended Dec. 31, leaving cumulative losses from its in-house v.c. arm at $6.7 billion. As recently as March 2021, those entities sported paper profits of $66.4 billion. Suffice it to say, recent events in the banking system are unlikely to help turn the tide. 
CreditSights cut its assessment of Masayoshi Son’s firm to underperform last week, citing the risk of “further write-downs to value within the Vision Funds, and SoftBank acting as a white knight to provide liquidity for portfolio companies.”
Sure enough, WeWork, Inc. announced a corporate restructuring days later, receiving $1 billion in new capital commitments and reaching a deal with lenders to cut some $1.5 billion in net debt. As part of that arrangement, SoftBank agreed to convert $1 billion of unsecured notes into equity. SoftBank, which had poured some $18.5 billion into the co-working concern by fall 2019 per comments from then-SoftBank COO Marcelo Claure, has seen its portfolio company’s market capitalization sink to $770 million. 
Could adverse actions from the rating agencies further complicate life for SoftBank? S&P Global warned Friday that “we may consider downgrading [double-B-plus-rated] SoftBank Group if we have stronger reservations about its strategic investment capability, because of the poor performance of its fund business.” 
The outcome of SoftBank’s efforts to break through a frozen IPO market this year with a listing of chipmaker Arm Ltd., a transaction that could potentially raise upwards of $8 billion per banker estimates, looms large. Noting that the proportion of listed assets within the two Vision Funds declined to 42% at year-end from 43% in September, S&P added that a downgrade could ensue if that metric fails to turn higher in the coming months. 
Recap March 21
The first day of spring brought more sunshine for the bulls, as the S&P 500 advanced by 1.3% to leave the broad index nearly 5% to the good for 2023. Treasurys have been having a bit more trouble of late, as the long bond rose eight basis points to 3.73% while the two-year yield bounced to 4.17% from 3.92% on Monday. Gold fell 2% to $1,943 an ounce, WTI crude tested $70 a barrel and the VIX settled near 21, down from near 26 yesterday morning.  
- Philip Grant
Draw a Bath
What memes may come:
What memes may come: Shares of Bed Bath & Beyond, Inc. (ticker: BBBY) plumbed new depths today, sinking 21% to as low as $0.78 after the company announced plans to hold a special shareholder meeting in hopes of authorizing a reverse stock split. That proposed rejiggering comes as the retail investor favorite faces potential delisting from the Nasdaq, as the exchange issued a formal warning to BBBY over that prospect at the end of January. Among other requirements, member firms must sport a stock price north of $1. 
Bed Bath, which managed to raise $135 million from the exercise of preferred stock warrants earlier this month, a transaction that analysts at Keybanc deemed to be among the “most unusual financing situations” they have seen in the past two decades, now sports an equity market cap of just $95 million.  As recently as August, that figure stood near $2 billion, a remarkable fact considering the purveyor of home furnishing’s 5.165% notes of 2044 changed hands at roughly 30 cents on the dollar at the same time, implying that a complete wipeout of shareholders was likely in the cards. 
One Direction
Will a spoonful of monetary sugar help the medicine go down?
Will a spoonful of monetary sugar help the medicine go down? On Sunday evening, the Federal Reserve and a quintet of other central banks celebrated the shotgun wedding of Credit Suisse and UBS by announcing that they will conduct daily – rather than weekly -- standing U.S. dollar swap auctions at least through the end of April, introducing an “important liquidity backstop to ease strains in global funding markets,” as the press release put it.  
The revival of a daily dollar facility, last used during the harrowing early days of the pandemic, comes as conditions in the Treasury market turn increasingly precarious: The ICE Bof A Move Index, which tracks volatility in that $24.6 trillion asset class, remains at extremes surpassing the chaotic March 2020 epoch. Likewise, trading volumes registered at roughly double their normal levels as of mid-week per strategists at BMO Capital Markets, while dealers relayed to The Wall Street Journal Wednesday that spreads between bid and offer prices on Treasurys and related derivative products had widened sharply relative to levels seen earlier in March.  
Thus, the white-knuckle price action in the short end of the curve last week, as two-year yields bounded to 3.81% from 4.6% while moving at least 17 basis points during session, underscored the fragile state of play. “We’re one crisis away from a complete breakdown of Treasury market liquidity,” Priya Misra, head of global rates research at TD Securities, warns the Financial Times.
A slowdown in activity within corporate credit compounds those ominous tidings.  Not a single deal priced within the U.S. investment grade realm over the six trading sessions through Friday, the longest non-holiday induced shutout since June. After a pair of issuers managed to break that drought this morning, high-grade supply stands at roughly $57 billion in the month-to-date, Bloomberg notes, well below the $155 billion that Wall Street had anticipated coming into March. Meanwhile, the most recent U.S. junk bond deal priced on March 2, while a net 44.8% of domestic banks reported tightening credit standards on commercial and industrial loans to large and middle-market firms, the Fed’s January survey of senior loan officers found. That ratio approaches the most stringent in recent memory, outside of the 2001 and 2008 recessions, as well as the 2020 crucible.
Accordingly, the Federal Open Market Committee’s Wednesday rate decision looms large, as still-raging inflation and a brewing banking crisis offer countervailing policy arguments. As of this morning, interest rate futures priced in 61% odds of a 25-basis point hike to the Funds rate, with a stand-pat outcome representing the minority view according to the CME Fed Watch tool. Compared to the 80% chance of a 50-basis point hike seen on March 8, two days before the demise of Silicon Valley Bank, the near-tossup outcome leaves central bank watchers on edge. “Since forward guidance began in 1994, there has not been a meeting with this much uncertainty so close to the meeting,” Bianco Research concludes.
Investors may need to buckle up, if one intragovernmental outfit gets its way. On Friday, the Organization for Economic Co-operation and Development raised their forecasted GDP growth to 1.5% in the U.S. and 2.6% worldwide this year, up from 0.5% and 2.2%, respectively, in November. A hawkish policy recommendation complemented those relatively upbeat growth assumptions: “We still think that, knowing what we know today, the priority has to be fighting inflation,” OECD chief economist Álvaro Pereira told the WSJ. “This isn’t 2008. We don’t see systemic risk at this stage.”  Referencing the ECB’s decision to press ahead with a 50-basis point hike last week, despite the unfolding drama surrounding Credit Suisse, Pereira declined to hedge his bets. “It was absolutely the right decision,” he contended.  
Recap March 20
Mr. Market remained in a good mood following the latest bank-related drama and policy response, as the S&P 500 gained 1%, though the Nasdaq 100 lagged this time with a 0.35% advance.  Treasurys came under modest pressure, relatively speaking, as the two-year yield rose 11 basis points to 3.92% while the long bond settled at 3.65% from 3.6% Friday. WTI crude rallied to near $68 per barrel, gold finished green again at $1,983 an ounce and the VIX retreated to 24. 
- Philip Grant
What's in a Name?
Here’s your headline of the day, from the Financial Times:
Pornhub owner sold to Canadian private equity firm Ethical Capital
Learning by Doing, Again
Talk about for-profit education.  A candid comment from Max Levchin, CEO of buy now, pay-later outfit Affirm Holdings, Inc., at an investor conference Wednesday (hat tip to executive commentary aggregator The Transcript):
I think this past week has been a lesson that risk is a lot more than just credit risk. Duration risk is a real thing.
Indeed, there’s all kinds of risk:
Affirm two-year price chart. Source: The Bloomberg
Yesterday, FTX Trading Ltd. filed court documents under ongoing Chapter 11 proceedings,
Yesterday, FTX Trading Ltd. filed court documents under ongoing Chapter 11 proceedings, identifying more than $3.2 billion in payments and loans to founders, including $2.2 billion to founder Sam Bankman-Fried himself.  
A further $240 million of company funds went to luxury property purchases in the sunny Bahamas, along with political and charitable donations by former management (how generous of them), the company trustees find.  Efforts to recover further funds continue apace, though the press release notes that “the amount and timing of eventual monetary recoveries cannot be predicted at this time.”
While Bankman-Fried’s former corporate plaything walks towards the light, another bankrupt crypto outfit finds a new home. On Tuesday, a federal court endorsed Voyager Global’s plan to sell $1 billion of assets to Binance.US, denying a government appeal to delay the transaction.  Judge Michael Wiles of the Southern District of New York determined that the deal terms “do not prohibit any regulatory action,” while ongoing delays represent “a massive issue for the Debtors’ customers” in their efforts to recover trapped funds. The deal is now set to close on Monday.
Meanwhile, the architects of a fellow defunct digital player migrate to greener pastures. Last week, the founders of failed crypto hedge fund Three Arrows Capital Ltd. claimed they have completed a $25 million fundraising round backing their latest startup, Open Exchange.  The newfangled trading platform will allow creditors of insolvent digital-asset firms (including Three Arrows itself) to buy and sell claims on those assets, operated in conjunction with senior executives at Seychelles-based bourse CoinFLEX, which itself initiated restructuring proceedings in August. 
Fittingly, perhaps, Open Exchange will “feature. . . a portfolio margin feature that was pioneered by FTX,” CoinDesk reported last week, citing comments from CEO Leslie Lamb on a Twitter Spaces broadcast. 
Risk-happy investors looking to transact in those claims now have a greater incentive to do so, thanks to rising collateral prices. Last week’s string of bank failures has – perhaps counterintuitively – ignited a serious rally in the crypto complex: the sector now sports a $1.13 trillion valuation according to Coinmarketcap.com, up 21% from last Friday afternoon, while the price of bitcoin reached $26,500, up 32% over the past seven days.  
See “Pennies on the dollar” in the current, March 10 edition of Grant’s Interest Rate Observer for a primer on the mechanics of the crypto claims process, along with the potential for those digital salvage operations. 
Recap March 17
Treasurys once again caught something resembling a panic bid, as the two-year yield plunged to 3.81% from 4.14% a day ago and the long bond fell to 3.6%, down 11 basis points on the day. Stocks pulled back a bit from the recent euphoria as the S&P 500 retreated by 1.2%, though tech continues to outperform  in the wake of the SVB depositor bailout as the Nasdaq 100 fell less than 0.5%. WTI crude plunged to $66.5 a barrel for its lowest finish since December 2021, gold ripped by 3.5% to $1,990 per ounce and the VIX jumped back above 25. 
- Philip Grant
Slam Dunk
From MarketWatch:
From MarketWatch:
A prominent group of YouTube financial influencers have become the targets of a class action lawsuit accusing them of leading their viewers into financial ruin by uncritically promoting failed crypto exchange FTX in return for lucrative sponsorship deals.
The suit, filed on Wednesday in federal court in Miami, argues that the network of influencers played a key role in drawing customers into using FTX by convincing them it was a genuinely safe platform in a sea of fraudulent operators and crypto scams.
On the bright side for those trend-setters, misery loves company. A Sunday dispatch from the New York Post:
NBA Hall of Famer and TV personality Shaquille O’Neal has been accused of avoiding being served a class-action lawsuit filed against celebrities who endorsed failed cryptocurrency giant FTX.
The former Los Angeles Lakers star was one of several high-profile celebrities — including Steph Curry, Tom Brady, Giselle Bündchen and Larry David — listed in the lawsuit filed by FTX retail investor Edwin Garrison, who claimed his crypto account went bankrupt after “being exposed to” the celebrity endorsements.
Garrison’s lawyers revealed that out of all the celebrities named in the suit, O’Neal was the sole person avoiding the lawyers and noted that the allegations against him were among the most damning. “It is really astonishing the measures he has gone [to] to avoid service of our complaint,” attorney Adam Moskowitz told Forbes. “The irony is that the admitted facts against him are probably the worst against any of the FTX brand ambassadors.”
Five Feet High and Rising
Learning by doing, redux:
Learning by doing, redux: The European Central Bank forged ahead with a 50-basis point rate hike this morning, leaving benchmark deposit rates at 3%, the highest level since October 2008 and compared to minus 0.5% as recently as July.  That salvo comes despite the stress in the global banking system, as the monetary mandarins argued that “inflation is projected to remain too high for too long.” 
The ECB’s move leaves cash-hungry corporations to fend for themselves. Today, Norway’s PGS ASA is marketing $450 million of senior secured notes at to help repay a term loan maturing next year, with price talk of 13% to 13.5%. At the midpoint of that range, the deal would top the 13.12% from Swedish energy outfit Preem Holdings last year to mark the region’s highest yield at issuance in recent history, Bloomberg notes.
Of course, the dynamic of constrictively high borrowing costs for speculative-grade credits is hardly confined to the Old Continent. Yesterday, option-adjusted spreads on the triple-C-rated tranche of Bloomberg’s U.S. High Yield Index reached 1,019 basis points, up from 860 basis points early last week and north of the 1,000 basis point pickup that typically indicates distress.  
With the benchmark Fed Funds rate now parked at 4.57%, compared to 0.2% a year ago, the bottom of the ratings barrel has precious little room for error.  Operating income among domestic triple-C-rated firms now covers interest expense by 1.6 times on average, BofA credit strategist Oleg Melentyev relayed last Friday, compared to 5.5 times interest coverage among high-yield as a whole.
Sure enough, the ranks of those unable to service their debts are expanding.  Global corporate defaults numbered 15 in February for the busiest single month since November 2020, a Monday analysis from S&P Global finds, while the two-month tally of 23 represents the highest over that stretch since 2009.  The bulk of that action comes from the U.S., with 16 defaults in the year-to-date through February, up from six over the same period in 2022.  
Stateside restructuring activity remains muted on a longer horizon, however, as the trailing 12-month U.S. speculative-grade default rate sits at 2.02%. That remains well below the long-term average of 4.1%, the rating agency relays, though those figures are up from 1.5% on July 31.  Meanwhile, the ranks of so-called weakest links, or firms rated single-B-minus or lower along with a negative credit outlook, stood at 191 at the end of January, up 50.3% from the end of June. 
Might the placid default environment that has long predominated be set to give way to some choppier financial seas? A Monday Bloomberg law analysis from Geoffrey Frankel, CEO of Hilco Corporate Finance, notes that total U.S. bankruptcies have been in near-constant retreat since 2009, reaching new cyclical lows in 2021 and 2022.
Yet beyond the rise in stressed and distressed credits, Frankel flags a broad-based markdown of loans issued by business development companies – both as a percentage of par value and in absolute dollar terms -- within the retail, food and drug, entertainment and leisure, automotive and health care sectors. Frankel concludes thus:
In the nearly 15 years since the Great Recession, the U.S. economy has managed to avoid a pervasive and sustained surge in corporate restructurings – with the notable exception of the initial wave of business failures resulting from the pandemic in 2020.  The accumulation of adverse market data throughout 2022 suggests that this time, something is different. 
QT Progress Report
About that QT…Reserve Bank credit increased by $142 billion from a week ago, thanks to the Fed’s Sunday evening rollout of its Bank Term Lending Program. Interest bearing assets on the Fed’s balance sheet now stand at $8.45 trillion, 5.3% below the March 2022 highs. 
Recap March 16
Maybe we should have more bank failures. Stocks ripped again with the S&P 500 gaining 1.7% while the Nasdaq 100 jumped 2.6% to bring its advance to near 5% since Silicon Valley Bank hit the wall last Friday morning.  Treasury yields rose with two-year note settling at 4.14%, up 21 basis points on the day, and the long bond edging to 3.71% from 3.7% yesterday, while WTI crude bounced above $68 a barrel and gold slipped to $1,923 per ounce. The VIX fell three points to 23. 
- Philip Grant
Wet your Whistle
A late-session communique from the Swiss National bank and the Swiss Financial Market Supervisory Authority, regarding perennially troubled Credit Suisse:
The SNB and FINMA are pointing out in this joint statement that there are no indications of a direct risk of contagion for Swiss institutions due to the current turmoil in the U.S. banking market.
Against this background, FINMA confirms that Credit Suisse meets the higher capital and liquidity requirements applicable to systemically important banks. In addition, the SNB will provide liquidity to the globally active bank if necessary. 
The old inverse hockey stick, CS 6 1/2s AT1 contingent convertible bonds (CoCos).  Source: The Bloomberg
Dancing in the Dark
What we have here, is a failure to communicate.
What we have here, is a failure to communicate. Investors hoping to transact in China’s $21 trillion onshore debt market received an unpleasant surprise this morning, as electronic portals used to provide pricing information turned blank. The comprehensive shutdown followed a Tuesday missive from the China Banking Insurance and Regulatory Commission instructing brokers to switch off their price feeds in response to “data security concerns,” Reuters reported.  
Some punters resorted to utilizing WeChat and other social media platforms to conduct their business, though that workaround hardly fills the bill for many participants in the world’s second-largest fixed income market. “Investors can survive a short-term aberration, but many Western entities don’t even allow the use of socials,” Brock Silvers, managing director at Hong Kong-based Kaiyuan Capital, pointed out to Bloomberg. “On a longer-term basis China’s bond market can’t be effectively run this way.”  A rival system operated by the People’s Bank of China remained up and running, though Bloomberg (itself a pricing provider) describes that platform as “hard to use and. . . less comprehensive.” 
Marketwide turnover declined between 30% and 60% from the previous day, various traders estimated to Bloomberg, with even the market’s most heavily trafficked security, a 10-year policy bank bond, logging a 14% downshift in trading volume from Tuesday’s session.  
That curveball from Beijing follows a persistent foreign retreat from the Middle Kingdom. Overseas investors reduced their holdings of local-pay bonds in the interbank market by RMB 107 billion ($14.9 billion) in January, official data show, marking the 11th such net outflow in that last 12 months.  Foreign holdings of RMB 3.28 trillion now sit at their lowest levels since December 2020.
Outsiders may have good reason to lighten up on their mainland-based positions, if the well-ventilated experience of one prominent investor is any guide. Earlier this month, Mobius Capital Partners founder and eponym Mark Mobius declared in an interview that “the government is restricting the flow of money out of the country. . . I’m personally affected because I have an account with HSBC in Shanghai. . . They don't say, 'No, you can't get your money out,' but they say, 'Give us all the records from 20 years of how you've made this money,' and so forth. It's crazy." 
Though the emerging markets mainstay subsequently told Hong Kong-based newspaper Ming Pao that the “problem has been resolved,” foreign investors hoping to repatriate their cash can expect plenty of hassles, especially considering that the greenback has appreciated by nearly 10% against the renminbi over the past year. An analysis yesterday from J Capital Research co-founder Anne Stevenson-Yang notes that “China has always made it much harder to extract capital than to invest it. When demand for dollars rises, though, the banks raise as many obstacles as possible.”  
Those efforts are not bearing fruit, however, as Chinese official reserve assets fell by $122 billion in 2022, despite a $878 billion trade surplus in goods. Beijing itself contributes to that leakage by sporadically selling dollars to strengthen the exchange rate and deal losses to investors who are short the RMB, as well as instructing commercial banks to purchase foreign exchange contracts, regardless of the commercial prospects of those transactions. “The partially open nature of China’s economy, an asset to the government in a rising market, is an obstacle to managing political optics in a falling one,” Stevenson-Yang writes.
Meanwhile, the slow-motion pileup of China’s lynchpin real estate industry finally shows signs of easing, as home sales by floor area fell by 3.6% year-over-year in January and February, government data from today show, a marked relative improvement from the 24% annual decline seen during 2022. Terming that slower decline “a good start to the recovery of the property market,” analysts at the E-house China Research and Development Institution predict to Reuters that first quarter sales figures will show an advance relative to 2022, marking “the biggest sign that the property market is recovering.”  
Yet, perhaps tellingly, the National Bureau of Statistics did not release land sales data, after developer purchases collapsed by 53% last year relative to 2021. See the current issue of Grant’s Interest Rate Observer for a closer look at the mechanisms behind China’s deflating property bubble, and the titanic quantities of debt that lurk off local government balance sheets.
Recap March 15
News of state support for Credit Suisse helped stocks charge higher into the bell, shaving losses on the S&P 500 to just 0.6%, though Treasurys remain in panic mode with the two-year yield settling at 3.93% from 5.05% a week ago. WTI crude continued its face plant by settling near $68 a barrel, gold rose to $1,923 per ounce and the VIX rose above 26.  
- Philip Grant
In the Eye of the Behodler
“A flight to quality” explains a recent jump in cryptocurrency
“A flight to quality” explains a recent jump in cryptocurrency trading volumes following last weekend’s events, Markus Thielen, head of research at digital financial services firm Matrixport, tells The Wall Street Journal.  Nearly $174 billion worth of the tokens changed hands yesterday according to CoinGecko, the highest 24 hour turnover since the aftermath of FTX’s collapse in November.  Yesterday’s spurt of activity coincided with happier times for crypto aficionados, as the price of bitcoin touched $26,300 this morning, up from less than $20,000 on Friday afternoon.  That development is particularly surprising considering that the trio of recent bank failures have served to impede prominent mechanisms for converting fiat to crypto and back again. 
Meanwhile, another avatar of the virus-era bull stampede enjoys a glimpse of the salad days.  The Ark Innovation ETF enjoyed a net $397 million of inflows on Friday, data from Bloomberg show.  That’s the most bountiful one-day haul since April 2021, equivalent to more than 5% of the fund’s assets under management. 
Treetop Flier
Private investors are on the hunt
Private investors are on the hunt following the venture capital-shaking collapse of Silicon Valley Bank. Bloomberg reports that p.e. giants Blackstone, Apollo, Ares Capital and KKR have indicated their interest in purchasing portions of SVB’s loan book, which stood at $73.6 billion at year-end. 
Similarly, a cadre of venture capital firms “are working on a long-shot plan to preserve parts of SVB,” the Financial Times relays, in hopes that the lender “can keep serving clients in the technology sector.” The prospective rescue team, which includes industry bold-facers Andreessen Horowitz, General Catalyst and Khosla Ventures, are reportedly looking to preserve SVB business lines that have become instrumental to the wider technology “ecosystem,” including its wealth management and investment banking units. 
The industry could use a little help, as a broad-based downshift was evident prior to the recent events. V.C. deal volume slumped below $40 billion in the fourth quarter, according to PitchBook, down more than 50% year-over-year and the weakest activity since prior to the pandemic.  With domestic IPO activity still in deep-freeze, exit activity registered at a meager $71.4 billion across 2022, the first sub-$100 billion annual showing since 2016.  Accordingly, those closest to the public markets finish line saw the worst of it, as the median late-stage valuation in 2022 slipped 10.3% year-over-year to $67.4 million. “We expect a plethora of down-rounds to occur in 2023 as the lack of liquidity options for many late-stage startups persists,” PitchBook warned in January. 
Luckily, a financial fixture in the Golden State may ride to the rescue. The California Public Employees’ Retirement System is considering a further increase in direct investments into privately held firms, reports BuyoutsInsider, which viewed a webcast of the firm’s investment committee meeting yesterday. 
The country’s largest pension system with some $442 billion in assets under management, CalPERS has made no secret of its ambition to ramp up direct investment into privately held companies and startups, with chief investment officer Nicole Musicco lamenting a “lost decade” of returns in September owing to an insufficient allocation to the booming category. CalPERS, which deployed $17 billion to private equity firms last year after ratcheting its p.e. portfolio allocation to 13% from 8%, added staff in late 2020 to ramp up its v.c. exposure, in turn targeting a 30% share of private holdings from the current 20% level. The firm marked its v.c. portfolio higher by 3% in fiscal 2022, the best-performing asset class in a year featuring a 6.1% overall decline over the 12 months through June.
Then again, the investing behemoth’s prior forays into the venture realm left something to be desired. As Business Insider documented in February, a $75 million, 2001 outlay into a Carlyle Group-managed fund lost money, while a further $75 million investment into a New Enterprise Associates vehicle that same year yielded a mere 2.7% internal annual rate of return. Those results compared to an industrywide average 3.9% IRR for that annual vintage, according to Cambridge Associates. Similarly, a $260 million investment in two funds managed by Khosla Associates in 2009 yielded IRRs of 11.8% and 6.9%, respectively, lagging the 14.7% benchmark for that year.  
More recently, CalPERS shelled out $300 million to Tiger Global last year, a fund known for its speedy capital deployment into portfolio companies. “Most of CalPERS’ commitment has already been spent,” Business Insider notes, “[that’s] an unusual pace in an industry where funds are usually deployed over 10 years.”
Recap March 14
All clear for the bulls?  Stocks jumped 1.6% on the S&P 500 thanks to notable late strength, after this morning’s reading of February CPI matched expectations with a 6% year-over-year headline advance.  Treasurys came under some pressure after the feverish recent rally, with two- and 30-year yields rising to 4.2% and 3.77%, respectively, up 15 and seven basis points on the session. Gold pulled back to $1,908, WTI crude slipped below $72 a barrel to log a 52-week low and the VIX retreated three points to near 24. 
- Philip Grant
Peanuts Brittle
What goes up, must come down?
What goes up, must come down?  Yesterday’s thunderbolt that the Federal Reserve will underpin deposits by loaning against Treasurys and other qualifying collateral at par following the demise of Silicon Valley Bank and Signature Bank loudly reverberates, not least in the short-term rates market.  
Two-year Treasury yields pancaked by as much as 60 basis points to 3.99%, extending beyond a 100-basis point, three-day decline for the largest such move since the October 1987 stock market crash.  Similarly, interest rate futures now price in a 4% policy rate by the end of the year, down from a 5.56% guesstimate last Wednesday as well as from the current 4.57% effective rate. 
That course correction follows dramatic structural changes ushered in by the Fed’s one-year-old tightening campaign. Citing data from CUSIP Global Services, The Wall Street Journal reports that investor demand for short-term certificates of deposit stands at its highest since the 2008 crisis, while money market funds sported $8.5 trillion in assets as of March 5 per the Federal Reserve Bank of New York, double that seen at the end of 2020. At the same time, the banking industry’s reluctance to pay up for customer funds is readily apparent, as the spread between S&P’s AAA-AA Money Market Rate and Bankrate’s average deposit rate towered at 395 basis points as of March 3 according to Bianco Research, up from 0.04% a year prior. “The fix is simple,” Bianco concludes. Lenders must “raise deposit rates. . . .”
More broadly, the banking system’s demonstrated vulnerabilities may serve to derail Fed chair Jerome Powell’s efforts at “normalization” following years of strenuous monetary easing. In fact, yesterday’s unveiling of the Bank Term Funding Program serves as a de facto reintroduction of the quantitative easing policy in force for large swaths of the post-2008 era, some believe. “The new BTFP facility is QE by another name,” strategists at Citi write. “Assets will grow on the Fed balance sheet, which will increase reserves. Although, technically, they are not buying securities, reserves will grow.” 
That prospective return to balance sheet expansion is ironic, considering that the Fed’s policy stance in the latter stages of the pandemic arguably laid the groundwork for the current snafu. Recall that the morning of June 10, 2021 brought news that headline CPI vaulted by 5% year-over-year in May, well above the 4.7% consensus and accelerating from a 1.7% annual pace just three months earlier.  That data point arrived a month after San Francisco Fed President Mary Daly declared that “it’s not yet time to start thinking about talking about relaxing the accommodation that we’ve given.”
Rather than pull back from the Covid-era policy pillars of near-zero interest rates and bountiful asset purchases, the Fed maintained the benchmark Funds rate at 0% to 0.25% while expanding Reserve Bank credit by $1.19 trillion over the subsequent nine months, despite the fact that measured price pressures increased in nearly every month during that stretch.  Even following 12 months of QT balance sheet runoff, the Fed’s holdings of interest-bearing assets remain at $8.3 trillion, roughly $400 billion north of the June 2021 level.
Indeed, that belated response to percolating inflation (along with the euphoric financial conditions that prevailed in 2021), is prologue to today’s difficulties, a recent analysis from Daly’s institution finds. Last month, the San Francisco Fed published Working Paper 2023-06, titled “Loose Monetary Policy and Financial Stability,” which concludes that “when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably.” Though some might consider that finding to be logically intuitive, the authors contend otherwise: “This study provides the first evidence that the stance of monetary policy has implications for the stability of the financial system.” See the current edition of Grant’s Interest Rate Observer dated March 10 for a counterpoint. 
Recap March 13
Intense curve steepening headlined today’s price action as the long bond remained at 3.7% while the two-year yields collapsed to 4.03% from 5.05% on Wednesday afternoon. Stocks managed to grind out a near-unchanged finish on the S&P 500 with the tech-heavy Nasdaq 100 rising 0.74%, though those indices finished well off their best levels of the afternoon, while gold ripped higher by nearly 3% to $1,919 an ounce and WTI crude slipped below $75 a barrel.  The VIX settled near 27, up two points on the day, after testing 31 this morning for its most elevated reading since October.   
- Philip Grant
Rear Window
From the financial afterthought department: nonfarm payrolls rose by 311,000 last month, the Bureau of Labor Statistics relayed this morning, topping the 225,000 consensus. That marks the 11th straight reading that came in hotter than economist expectation, the longest streak since Bloomberg began compiling those data in 1998. At the same time, the labor force participation rate ticked to 62.5%, the highest share since the onset of the pandemic, while the median duration of unemployment slipped to 8.3 weeks, the shortest span since July. 
Easy money aficionados did enjoy one bit of “good” news, as average hourly earnings rose by 4.6% from a year ago, just shy of the 4.7% consensus. Year-over-year real wage growth has now remained in negative territory for 23 consecutive months. 
Built to Spill
It’s been a week to remember in all the wrong ways
It’s been a week to remember in all the wrong ways for the domestic banking industry, as cascading selloffs followed yesterday’s revelation that Silicon Valley Bank swallowed hefty losses on its bond portfolio to meet deposit redemption requests.  
Resolution on that score was not long in the making. The Federal Deposit Insurance Corp. announced that California regulators have closed the bank’s doors, hours after CNBC reported that parent firm SVB Financial Group (ticker: SIVB) was grasping for a buyer to save the day. Marking the second-largest bank failure in U.S. history following Washington Mutual’s 2008 demise, SVB sported $209 billion in assets as of Dec. 31. Total deposits stood at $175.4 billion, with $151.6 billion of those uninsured.  Those with deposits in excess of the FDIC’s $250,000 insurance threshold will receive a receivership certificate for their funds, with payments to follow as the regulator sells down remaining assets.
Deemed the “bank of the cycle” in the Nov. 15, 2019, edition of Grant’s Interest Rate Observer (it was no compliment), SVB wilted under the weight of the dramatic interest rate whipsaw seen in recent years, even as shares tripled over the two years following that bearish analysis. In tandem with that euphoria, the lender attracted a surge in venture capital-driven deposits as borrowing costs cratered during the pandemic, investing much of those funds into longer duration Treasurys and other “low risk” securities at interest rates now far below prevailing levels, thus setting the stage for this week’s fireworks. 
“The funding pressures facing SIVB are highly idiosyncratic and should not be viewed as a read-across to other regional banks,” analysts at Morgan Stanley contended this morning. Mr. Market begs to differ, as a litany of lenders have likewise gone through the wringer. Among that hapless cohort: Los Angeles-based PacWest Bancorp (ticker: PACW), which has absorbed a 52% share price selloff over the past two days. 
Fast-growing PacWest, which sported $41.2 billion in assets as of Dec. 31, compared to $29.5 billion at the end of 2020, likewise fattened up on fixed income securities prior to the recent lurch higher in interest rates, helping spur a bearish analysis in the June 10 issue of Grant’s Interest Rate Observer
“The Fed created a perfect trap for the banking system,” Ben Mackovak, co-founder of Strategic Value Bank Partners, presciently told Grant’s last year. “You couldn’t find yield anywhere. So you would get a call from a bond salesman or investment banker saying, ‘Hey, you got to optimize your balance sheet. Here are some 30-year mortgages at 3%.’ And they would tell the banks that,  in reality, those aren’t 30-year instruments. The average duration is like seven years, because people move, get jobs, refinance.” Of course, events have proven that shopping spree to be less than timely. Witness the swan-dive in PacWest’s 7 3/4% perpetual preferred stock, which figured prominently in that 2022 analysis:
Meanwhile, another niche lender that thrived in ZIRP times tries to stem the damage.  Big Apple based-Signature Bank Corp. (ticker: SBNY), the subject of a bearish Grant’s Interest Rate Observer verdict on July 24, 2020, issued a press release yesterday trumpeting a “proven, stable commercial banking business. . .diversified deposit mix. . . [and] a high level of capital,” featuring a 10.42% common equity tier 1 capital ratio at year-end, well above the 6% regulatory minimum.  Yet considering that total assets rocketed to $110.3 billion as of Dec. 31, up 49% on a two-year basis, investors were more than content to sell first and ask questions later. SBNY shares endured a 23% wipeout, the worst one-day showing since its 2004 IPO. 
“The whole sector is in crisis, and the banks and investors that support these assets are going to have to figure out what to do,” Christopher Whalen, publisher of The Institutional Risk Analyst, told Grant’s back in summer 2020.  Though the banking industry virtuoso was referring to a de facto NYC rent holiday in the wake of the pandemic, those words of warning are widely applicable today. 
Recap March 10
Another round of panic buying in short-dated Treasurys headlined todays price action as the two-year yields plunged to 4.6%, a stunning 45 basis points below Wednesday’s close, while the long bond rallied to 3.7% from 3.88% yesterday. Stocks sank by 1.4% on the S&P 500 to wrap up a brutal minus 4.2% showing for the week and narrow the 2023 advance to less than 2%, while WTI crude rose to near $77 a barrel and gold ripped 2% to $1,872 per ounce.  The VIX rose two points to 24.7 for its most elevated close of the year, though the volatility gauge finished well off its intraday high. 
- Philip Grant
Flood the Zone
The new Nasdaq” enjoys some exponential growth of its own. From the Financial Times:
Cathie Wood’s Ark Investment Management has earned more than $300 million in fees on its flagship exchange traded fund [ticker: ARKK] since its inception nine years ago, while wiping out almost $10 billion of investors’ cash in the same period.
Ark has earned more than 70% of its $310 million fees since the fund’s valuation plummeted by nearly three quarters from its high in February 2021, according to FactSet data. This year it has brought in an average of roughly $230,000 in fees a day as ARKK’s value recovered slightly, rising by a quarter.
Ark, which currently manages some $7.3 billion in assets, charges a 0.75% annual management fee, compared to 20 basis points for the Invesco QQQ Trust, Series 1, which tracks the Nasdaq 100. That NDX proxy sits 26% below its 2021 high-water mark and sports a 76% five-year return, compared to a 76% post-2021 drawdown and minus 11% five-year performance for ARKK. 
Fast Money
The diet starts tomorrow.
The diet starts tomorrow.  Fed chair Jerome Powell identified fat profit margins as one factor driving explosive post-pandemic price pressures in Congressional testimony this week. Relief may be forthcoming on that front, however: “As supply chains get fixed and shortages are alleviated, you will see . . . inflation coming down, you’ll see margins coming down,” Powell predicted. 
To be sure, corporate America made hay as the bug barged in. A U.S. Department of Commerce-compiled measure of aggregate after-tax margins among U.S. nonfinancial firms registered at 14.91% in the three months through September (the most recently available data), marking the seventh consecutive quarter north of 14%. Prior to the pandemic, that figure last reached 14% in the early 1950s, while topping the 12% threshold only during the mid-aughts and from 2012 to 2015. 
Might the historic bottom-line gusher finally be set to ebb? Blended net profit margins across the S&P 500 stand at 11.3% for the fourth quarter with 99% of the index having reported, FactSet analyst John butters relayed Monday, down 60 basis points on a sequential basis to edge below the five-year average of 11.4%. 
At the same time, analysts are taking the proverbial red pen to estimates for the current quarter, collectively slashing the S&P’s bottom-up EPS projection by 5.7% during January and February. That compares to an average 1.4% haircut over the first two months of the year going back to 2003.
A lasting profitability downshift could usher in broader trouble, some believe, as businesses respond to that dynamic by shedding jobs and curtailing new investment. As Société Générale strategist Albert Edwards pointed out yesterday, a category of monthly durable goods data – non-defense capital goods orders ex-aircraft – serves as a dependable indicator of general business investment spending. 
Though headline durable goods orders are up a sturdy 16% over the past two years on a nominal basis, that stripped-down capital goods gauge remained flat on an inflation-adjusted basis in 2021 and has since turned markedly lower in real terms.  
What’s more, corporate fixed investment, which has closely tracked changes in durable goods going back to 1980, fell by 4.6% on an annualized, seasonally adjusted basis in the fourth quarter, the Bureau of Economic Analysis finds, following 3.5% and 5% respective retreats over the preceding three-month periods. The current slump stands as easily the most protracted since the financial crisis (investment plunged by 28.9% during the teeth of the lockdowns before snapping higher by 29.2% in the next quarter), spurring a mention from Powell in his prepared remarks Tuesday. “That is the stuff of recession,” Edwards concludes. 
QT Progress Report
Reserve Bank credit fell by $27.5 billion from a week ago, leaving the Fed’s cache of interest-bearing assets at $8.3 trillion. That’s 6.9% below the March 2022 highs, and $93 billion south of last month’s reading. 
Recap March 9
News that venture capital-focused Silicon Valley Bank swallowed a $1.8 billion loss selling assets in response to dwindling deposits touched off some serious bloodletting, as the Financial Select Sector SPDR Fund (ticker: XLF) and the SPDR S&P Regional Banking ETF (ticker: KRE) sank by 4.1% and 8.1%, respectively, while the S&P 500 lost 1.8% to shave its 2023 gains to less than 3%.  Treasurys meanwhile saw a violent bull-steepening rally, with two-year yields plunging 15 basis points to 4.9% and the long bond holding at 3.88%.  Gold rebounded to $1,835 per ounce, WTI crude slipped below $76 per barrel and the VIX jumped to 22.6, testing its year-to-date highs. 
- Philip Grant
Swiss Miss
“The SNB’s monetary policy is still too loose
“The SNB’s monetary policy is still too loose to return inflation back to price stability in the medium term,” Swiss National Bank chair Thomas Jordan declared in a speech today. Those remarks come a day after February CPI showed a 3.4% year-over-year advance, within 10 basis points of the cyclical high reached in August.  The SNB, which has tightened policy by 175 basis points since June after eight years with a negative 75 basis point benchmark rate, “has to act to reach price stability in the medium-term,” Jordan added.
The hangover from those prior monetary exertions, which featured Jordan et al. hoovering up euros to suppress unwanted strength in the franc, then diversifying into other currencies by buying, among other things, U.S. stocks, continues apace. Yesterday, the SNB reported a CHF 132.5 billion ($141.5 billion) annual loss in 2022, in line with provisional estimates. That shortfall, the largest in the bank’s 115-year history and a sum equivalent to about 17% of Swiss nominal GDP last year, wiped out the SNB’s CHF 102.5 billion distribution reserve with room to spare, meaning the central bank will not issue a payout to the central or regional governments for only the second time since its founding in 1907. 
Capital Punishment
Save us, Masa Son.
Save us, Masa Son. Chipmaker Arm Ltd. will attempt to knock the cobwebs off a dusty IPO market in the coming weeks, as the SoftBank portfolio company plans to submit paperwork for a U.S. listing by late April, CNBC reported Sunday. The Cambridge, England-based firm is aiming high, targeting $8 billion in fresh funding and a valuation north of $50 billion, after antitrust regulators on both sides of the Atlantic put the kibosh on Nvidia’s planned acquisition of Arm for $40 billion last year.
Just 17 firms have priced conventional IPOs (rather than coming public via mergers with special purpose acquisition companies) in the year to date, raising an aggregate $1.7 billion, data from Renaissance Capital show, roughly on pace with the 71 completed deals and $7.1 billion in fundraising seen throughout 2022. For context, the prior two bumper-crop years featured a combined 618 debuts and $221 billion in total proceeds.
Operating results from a key contingent of the bygone boom have not been pretty. The Financial Times relayed yesterday that just 17 of the 91 technology firms that came public in 2020 or 2021 and have reported results this year managed a net profit a year ago. That cohort collectively burned through $12 billion in cash during 2022 – a figure that includes AirBnB’s positive $2.5 billion in free cash flow, after adjusting for stock-based compensation – while nearly half posted an operating loss. Share prices among those 91 are down 35% on average since listing, while, if last year’s cash depletion rates persist into 2023, almost one-third of that group would run out of cash by the end of the year, the pink paper warns. 
Sure enough, some freshly public firms have decided that the grass is greener on the other side of the fence. Ten companies that IPO’d in 2020 and 2021 have already returned to the private markets through leveraged buyouts, The Wall Street Journal relayed on Feb. 19, citing Dealogic, with others expected to follow in the coming months per bankers and executives. For context, eight entities from the 2018 and 2019 IPO classes have since returned to private ownership. 
Things are hardly better within the ranks of roughly 850 firms that came public via the SPAC route during the virus-era euphoria. Eight of those have already filed for Chapter 11 bankruptcy, Bloomberg Businessweek relayed last week, with nearly 100 others on pace to run out of cash within the next year. An additional 73 sport share prices south of $1, putting them at risk of delisting, while a dozen corporations have agreed to buyouts for less than their listing price. 
Meanwhile, a pile-up of hopefuls face a fast-ticking clock, as more than 70 SPACs holding some $18 billion in cash face liquidation during the next 30 days, data from Bloomberg show.  More than 30 of the blank check firms, which are usually obliged to liquidate if they do not find a deal within a two-year span, have already turned the lights off so far in 2023. Those figures could represent the tip of the iceberg barring an imminent improvement in the financial weather, as 335 blind pools holding a combined $72 billion in cash are still in search of a merger target. 
“The value destruction has been spectacular,” Dan Zwirn, co-founder of Arena Investors, marveled to Bloomberg Businessweek.  
Recap March 7
Mr. Market didn’t like what he heard from Fed chair Jerome Powell today, as stocks retreated by 1.5% on the S&P 500, with the broad average settling near its worst levels of the session. An already upside-down yield curve further entangled itself, as two-year yields reached 5% for the first time since 2007 while the long bond dropped four basis points to 3.88%. A screaming rally in the dollar left gold at $1,89 per ounce and WTI crude at $77 per barrel, down about 2% and 4%, respectively, and the VIX rose a point to approach 20. 
- Philip Grant
American Idle
From the Tallahassee Democrat:
Aber-clam Lincoln, a quahog clam believed to be 214 years old, was released into the Gulf of Mexico last week by his caretakers at the Gulf Specimen Marine Lab.  AmeriCorps member Blaine Parker dug up the 2-century-old mollusk at Florida's Alligator Point, while collecting shellfish to make chowder.
Scientists believe incredible low metabolic rates of Lincoln and other quahogs are responsible for their long lives. A 2018 University of Kansas study on the energy needs of 299 species of extinct and living bivalves found those with minimal energy requirements escaped extinction.
“The lower the metabolic rate, the more likely the species you belong to will survive,” Bruce Lieberman, the study’s co-leader, said in a statement at the time. “Instead of survival of the fittest, maybe a better metaphor for the history of life is survival of the laziest, or at least survival of the sluggish,” Lieberman said.
Don’t tell the standing-desk crowd. 
Pain and Teller
Lower for longer’s last gasp:
Lower for longer’s last gasp: Sharply rising interest rates are slow to take hold for some on the Old Continent, as German lenders are currently shelling out just seven basis points to depositors on average, the Financial Times reports, citing data from financial technology firm Raisin. Similarly, Spanish banks offered 0.37% on new household deposits of one year or longer in January, down from 0.42% a month earlier, the European Central Bank relayed Friday. 
Those paltry payouts pale next to the 2.5% currently on offer at the ECB overnight deposit facility utilized by commercial banks. “This is clearly unfair from a customer’s point of view,” Raisin CEO Tamaz Georgadze argues to the FT
Some stateside banks, meanwhile, have been a bit quicker off the dime.  Bloomberg reports today that more than a dozen firms, including Capital One Financial, are now offering 5% yields on one-year certificates of deposit, while mega-lender Wells Fargo paying out 4% on an 11-month CD. Yet those elevated payouts remain the exception to the rule, as average one-year CD rates stand at roughly 1.5%, up from the 0.25% on offer a year ago but well below the 4.57% effective Fed Funds rate. 
Considering that yawning gap to so-called risk-free rates, it is perhaps no surprise that banks endured a $278 billion net withdrawal in commercial deposits last year, according to the Federal Deposit Insurance Corp., the first annual decline since 1948.  Total bank deposits likewise dropped on a sequential basis in each of the last three quarters of 2022, the longest such streak of the post-crisis era. In an effort to replace those funds, lenders have turned to Uncle Sam: advances from the Federal Home Loan Bank system reached $587 billion as of Dec. 31, more than triple the $188 billion balance a year prior. That financing is relatively expensive, however, costing as much as 5%. 
“I think banks had gotten – understandably – very used to significant liquidity and very low rates,” Jill Cetina, associate managing director at Moody’s Investors Service, declared at a conference last week. “Now we are starting to see some pressures emerge.”
Sure enough, the reversal of those longstanding dynamics is taking a toll on profitability, as average funding costs for U.S. lenders reached 1.14% at year-end, a Feb. 22 analysis from S&P Global Markets concluded, up 99 basis points year-over-year. Considering that the bulk of that increase took place during the fourth quarter, as well as the fact that markets and policymakers alike now expect the Fed’s tightening cycle to persist well into 2023, continued rate rises could soon sting. “The question is really about lags,” commented JPMorgan Chase CFO Jeremy Barnum last month. “It’s just common sense to expect [deposit costs] to catch up” with the broader rise in interest rates.  
Indeed, the fact that roughly 23% of money market deposits from commercial middle market firms are currently earning fewer than 75 basis points underscores “a lot of pent-up risks for banks” Peter Serene, director of commercial banking at consulting firm Curinos, warned S&P. 
At the same time, bad loans are creeping higher as the virus-era stimmies jubilee fades into the rear view. The rate of net charge-offs across the U.S. banking system reached 0.36% over the last three months of 2022 according to the FDIC quarterly banking profile. Though still south of the 0.54% logged on the eve of the pandemic, that marks the fifth consecutive sequential increase following a 0.19% reading in the third quarter of 2021, the lowest on record going back to 1986.  
See the issue of Grant’s Interest Rate Observer dated Jan. 27 for more on the confluence of adverse dynamics faced by the banking industry in the wake of the zero-interest-rate era, along with the risks that tougher industry conditions may introduce to the market at large. 
Recap March 6
Stocks finished little changed on the S&P 500 as an early push higher lost momentum in the afternoon, while Treasurys traded a bit weaker across the curve ahead of Fed chair Jerome Powell’s Congressional testimony tomorrow and Wednesday. Gold ticked lower to $1,852 an ounce, WTI crude climbed above $80 a barrel to log a near-six-week high and the VIX edged higher toward 19.  
- Philip Grant
Ok Boomer Capital, LP
The kids are all set, thanks. From Bloomberg: 
An exchange-traded fund tracking U.S. companies that adhere to the values of Generation Z is shuttering hardly more than a year after its [debut].
The Generation Z ETF (ticker ZGEN), which launched at the end of 2021 and counts companies like Duolingo Inc. and Tesla Inc. among its top holdings, will cease trading and be closed for purchases at the end of the session on March 17. Behind its launch were Julian Feder and Eitan Prins-Trachtenberg, both teenagers at the time of the fund’s inception. . . The ETF has fallen 26% over the past year through Thursday and has seen minimal inflows during its lifetime.
The fund lasted longer than a Tik Tok video, at least.
Plateau Pétrus
One step back, two steps forward?
One step back, two steps forward?  Last year’s bruising price action didn’t put a stop to the private equity machine, as the buyout industry kept humming along despite bear market conditions and a virtually shuttered IPO market. Though worldwide buyout activity across 2022 fell 35% year-over-year to $654 billion, Bain Capital documents in its newly released, 14th Annual Global Private Equity report, that output nevertheless towers over pre-Covid showings which never topped $500 billion during the eight years through 2019. Similarly, global fundraising by so-called alternative asset managers footed to $1.3 trillion, down 10% from 2021’s record figure but still the second-highest cash intake on record. 
“So far this year there has been a continuing slowdown in the action, but private equity’s long-term appeal to investors is secure,” commented Hugh MacArthur, chairman of global private equity at Bain. “There is undeniable uncertainty in the global market – but this is something that p.e. has dealt with and persevered through before.”
Of course, interest rates have risen before, but rarely so suddenly as over the past year: Buyout firms with direct lending businesses doled out $151.3 billion to middle market borrowers in 2022 according to Refinitv, down 23% from the prior year’s peak. Yet that figure still stands 41% above that seen in 2020. Private lenders are taking share in leveraged finance, as Wall Street banks continue to lick their wounds after being stuck with billions in buyout-related loans that they were unable to offload to investors.  
That dynamic increasingly applies to the larger transactions, as “multibillion-dollar M&A deals can now credibly consider private credit as an option,” Mike Patterson, governing partner at HPS Investment Partners, told Bloomberg Monday. Indeed, a consortium of p.e. firms has committed to provide a $5.5 billion loan to help Carlyle Group purchase a 50% stake in healthcare technology firm Cotiviti, Inc. That deal, which reportedly may include a pay-in-kind provision permitting the borrower to make interest payments in the form of additional debt rather than cash, would mark the largest private credit transaction on record, topping the $5 billion backing last year’s buyout of software firm Zendesk, Inc.
While the buyout industry takes the private credit market to new heights, conventional credit lenders are waving in the type of deals typically seen during go-go bull market conditions. Bloomberg relayed Tuesday that p.e. promoters have priced eight domestic leveraged loan offerings this year in which proceeds were at least partly devoted to paying themselves dividends, compared to just two such transactions over the three months through December. Similarly, such dividend recapitalizations have accounted for 12% of leveraged loan volumes in Europe since Jan. 1, up from a 4% clip across 2022. The market’s appetite for those deals is all the more impressive considering that overall loan volume sits at just $42 billion in the year-to-date, 57% below 2022’s pace, data from LCD show.
Meanwhile, the private capital industry at large sat on a towering $3.7 trillion of dry powder as of Dec. 31 according to Bain Capital, up 15.6% from the prior year and well above the $2.5 trillion stockpile of committed cash reserves on the eve of the pandemic.  
If any buyout barons find that capital burning a hole in their pocket, Xi Jinping and friends have just the ticket. Last week, The China Securities Regulatory Commission announced the commencement of a pilot program permitting p.e. funds to invest in residential and commercial real estate projects in the Middle Kingdom, reversing longstanding restrictions on outside investment as that grotesquely leveraged, lynchpin sector has gone through the wringer following mega-developer China Evergrande’s December 2021 default. 
“The policy will provide new funding sources to revive existing property assets,” Yan Yuejin, director of the E-house China Research and Development Institution, told the South China Morning Post. “These p.e. funds have big potential to participate in ensuring deliveries of housing projects and merger and acquisitions of real estate assets. It’s positive for [the prospect of addressing] some developers’ distressed assets.” 
One at a time, p.e. tycoons. 
Recap March 3
The bulls are back in the saddle, as stocks ripped higher by 1.6% on the S&P 500 to leave the broad index higher by 6.1% in the year-to-date, while Treasurys enjoyed a potent bull-flattening rally with the long bond sinking 13 basis points to 3.90%.  Gold maintained recent momentum with a 1% advance to $1,861 per ounce, WTI crude tested $80 a barrel and the VIX tumbled to 18.5 after settling near 21 on Monday. 
- Philip Grant
Squeaky Wheel
Who needs the repo man anyway?  From Bloomberg:
Ford Motor Co. has filed for a patent on technology that could remotely shut down your radio or air conditioning, lock you out of your vehicle, or prompt it to ceaselessly beep if you miss car payments. Ford said it has no plans to use the technology.
Location, Location, Location
No slowdown here:
No slowdown here: Data centers remain all the rage for dealmakers. Citing data from Synergy Research Group, The Wall Street Journal reported last week that merger and acquisition volume for that corner of the real estate market registered at $48 billion in 2022, just off the record $49 billion logged in the prior year. In contrast, total global M&A slumped to $832 billion a year ago from $1.48 trillion in 2021 per S&P Global Markets, marking the weakest tally since at least 2017.  
Private equity firms were central to that resilience, accounting for 90% of data center deal volume a year ago, compared to about two-thirds in 2021. Headlining that shopping spree: KKR’s $15 billion purchase of Dallas-based CyrusOne, Inc., last winter. “These are really big deals and big checks,” Jon Lin, executive vice president at Equinix, the largest data center firm by sales, marveled to the Journal.
Pricing tailwinds helped drive that dynamic, as average monthly rates for those digital landlords jumped 14.6% in 2022 to $137.9 per kilowatt of power consumed, the first annual increase in five years, CBRE Group finds, thanks to tight supply along with rising construction and labor costs. “Large-scale p.e. investors are clearly attracted to the continued, robust take-up of data-center space by large hyperscale and social-media companies,” Pat Lynch, executive managing director at CBRE, observed to the WSJ
Yet that strength in hyperscale, meaning wholesale leases to the likes of mega-cloud providers like Amazon and Microsoft, does little to help the bruising conditions within the higher-margin colocation business, in which multiple tenants operate in the same building.  
Indeed, the widespread migration to the cloud further complicates life for data center REITs. The industry is contending with broadly shrinking returns on capital, argued a pair of bearish analyses in the May 28, 2021 and Sept. 2, 2022 editions of Grant’s Interest Rate Observer, compounded by technological obsolescence risks and aggressive capital structures ill-suited to the recent lurch higher in borrowing costs. The private equity shopping spree documented above represents no manna for publicly traded peers, as buyers look to add capacity to justify their investment, keeping a lid on pricing power.
Cyxtera Technologies, Inc. (ticker: CYXT), represents something of a poster child for the industry’s woes. Termed “arguably the worst-positioned” in the sector by Grant’s in 2021, the Coral Gables, Fla.-based firm is now gasping for air, as Bloomberg reported Tuesday that the encumbered digital landlord has entered negotiations with lenders in hopes of extending maturities on its borrowings, including a $120 million revolver due this coming fall. That follows a December downgrade to triple-C from single-B-minus by S&P, in which the ratings agency warned that CYXT is on pace to run out of cash by September.  Shares are off 77% since Grant’s had its say. 
A potential debt restructuring would reverberate, particularly for Digital Realty Trust, Inc. (ticker: DLR), the second-largest industry player. Cyxtera (which leases the bulk of its facilities from third-party landlords) represented DLR’s 12th-largest tenant as of Dec. 31, accounting for 1.7% of rents last year. Then, too, the fellow data center sports a weighted average lease term of 9.4 years, longer than any of the 11 firms that contribute a higher share of Digital Realty’s rental revenue.   
Signs of trouble are likewise popping up at DLR, which disclosed the termination of its chief operating officer in January in tandem with a “broader organizational realignment,” weeks after the board of directors showed CEO Bill Stein the door. That overhaul comes after return on assets and return on equity slumped to 0.99% and 2.03% respectively, in 2022, far below the 4.72% and 9.68% figures generated in the prior year. 
Yet despite a 22% selloff since Sept. 2, exceeding the 7% decline in the S&P 500 over that period (both figures inclusive of reinvested dividends), Digital Realty continues to command a $50 billion enterprise value, equivalent to 18.5 times the $2.7 billion in adjusted Ebitda that J.P. Morgan analysts expect this year. Net leverage, meanwhile, stands at 6.9 turns of annualized fourth quarter Ebitda after factoring in joint ventures and preferreds, analysts at CreditSights calculate. 
Digital Realty, which resides in the basement of investment grade with a triple-B rating from S&P, shelled out $2.5 billion in capital expenditures last year against just $1.68 billion in cash flow from operations, while diluted funds from operations shrank by 5.1% on a year-over-year basis despite a 5.9% uptick in revenues. “This is the basic problem for the sector: It needs to spend ever greater sums just to stay put,” Grant’s concluded last year.  
QT Progress Report
A $16.4 billion weekly decline in Reserve Bank credit shrinks the Fed’s portfolio of interest-bearing assets at $8.33 trillion. That’s 6.6% below the peak logged just under a year ago, and $91 billion below last month’s reading. 
Recap March 2
It was a Bostic barbeque for the bears today, as dovish rhetoric from the Atlanta Fed President teed up a strong afternoon rally to leave the S&P 500 higher by nearly 1% after sitting in the red through lunchtime.  Treasurys, however, were unable to get off the mat, with a bear-steepening selloff pushing the long bond to 4.03%, up six basis points on the day.  WTI crude held near $78 a barrel, gold edged lower to $1,843 per ounce and the VIX dropped nearly a full point settle south of 20. 
- Philip Grant
Talk Soup
The mood among U.S. executives is on the mend,
The mood among U.S. executives is on the mend, as a survey of CEOs conducted by the Washington Service showed a third consecutive increase in business confidence last month, reaching the highest level since March of last year. 
Actions tell a slightly different story, however. Corporate insiders sold shares in their respective companies at four times the rate that they bought in February, the analytics firm finds, marking the highest such ratio since spring 2021.  
The appearance of broad-based corporate accumulation has helped signal major cyclical turning points: insider purchases outpaced sales by 1.75:1 in March 2020, which represented the best monthly showing since March 2009.    
Liquid Courage
Open wide, Mr. Market.
Open wide, Mr. Market. February was a month to remember in the high-grade credit realm, as domestic issuance reached a hefty $154 billion, strategists at Bank of America relay.  That’s the most on record for February, nearly doubling the $85 billion that came to market in that period last year.
Surging supply wasn’t the only noteworthy dynamic seen last month, as investors readily bid for long-duration debt.  The share of new issues maturing in 10 years or longer registered at 25% of the total per BofA’s count, up from just 6% in January and 10% in November of last year. 
That explosive showing from primary markets is even more noteworthy considering the circumstances, as a series of hotter-than expected employment and inflation data served to quash hopes of an imminent end to the Fed’s tightening cycle. To that end, Bloomberg’s global gauge of investment-grade credit logged a negative 3.32% total return for the month, the ninth worst performance in any single month going back to March 1990 and erasing nearly $327 billion in notional value, a sum greater than Chile’s nominal economic output last year.  
In terms of the domestic high-grade universe, last month’s retreat leaves the Bloomberg U.S. Aggregate Index 14.3% below its high-water mark reached in August 2020 but above the 18.4% nadir seen in late October. Even with that recovery, the corporate bond drawdown remains the most acute since at least the late 1970s, Bianco Research relays, exceeding the 12.7% peak-to-trough move seen in early 1980.
While creditors lick their wounds following that gruesome February showing, the relentless move higher in so-called risk-free rates could serve to complicate the prospects for any imminent recovery. Yesterday, the yield on six-month Treasury bills rose to 5.17%, up from 0.6% a year ago and the highest since 2007.  
Not only does that top the 5.07% which is on offer from the classic 60/40 portfolio (utilizing the earnings yield on the S&P 500 and the yield to maturity on the U.S. Agg,, respectively) for the first time since 2001 by Bloomberg’s lights, but six-month bills now sport a higher yield than 754 of the 2,596 issues within the iShares iBoxx $ Investment Grade Corporate Bond ETF (ticker: LQD), a whopping 29% share. The LQD itself, which included a 47.3% weighting of bonds rated triple B, or the last full rating stop before junk, as of Dec. 31, carries a 5.46% average yield-to-maturity, before factoring in the 14-basis point annual expense ratio. 
Strategists at Morgan Stanley aptly sum things up: “After a 15-year period often defined by the intense cost of holding cash and not participating in markets, hawkish policy is rewarding caution.”
Recap March 1
Stocks fluttered lower again with the S&P 500 and Nasdaq 100 slipping by 0.4% and 0.8%, respectively, though stronger-than expected results from Salesforce.com after the bell could give the bulls a lift tomorrow.  Treasurys came under broad-based pressure once again, as the long bond rose four basis points to 3.97% and the two-year yield reaching another cyclical high of 4.89%, while gold rose to $1,844 per ounce and WTI crude edged higher to approach $78 per barrel. 
- Philip Grant
Out go the artisan income statements:
Out go the artisan income statements: The Securities and Exchange Commission is turning up the heat on firms that emphasize bespoke performance metrics. The regulator released updated guidance in December for firms that stray from generally accepted accounting principles (GAAP), warning that such practices – i.e., presenting inconsistent metrics between reporting periods or excluding non-recurring charges without doing the same for one-time gains – would be considered individually tailored and therefore misleading. 
Subsequently, the SEC has sent letters to 20 companies questioning their use of non-GAAP metrics, The Wall Street Journal reports, citing data from provider MyLogIQ, up from 11 such communiques over the first two months of 2022.  That number will likely grow in the coming months, predicts Olga Usvyatsky, former vice president at Ideagen Audit Analytics, considering the SEC’s newfound emphasis on the topic and the fact that such correspondence is typically made public 20 days after resolution. Thus, inquiries from the quarter ended in December should see the light of day this spring.  
Among the chastised cohort: Lyft, Inc., which invited SEC scrutiny for adding back reserves against potential future insurance claims to its in-house adjusted Ebitda metric. After the agency instructed the ride share firm to remove that adjustment from its calculations, Lyft reported negative $248.3 million in adjusted Ebitda over the three months through December, compared to minus $47.6 million in the prior year period, after increasing its insurance reserves by $375 million in the fourth quarter.
Some on Wall Street, at least, have welcomed the non-GAAP crackdown with open arms. “We see this as a huge positive for capital market efficiency,” Northcoast Research Partners’ Ryan Connors wrote on Jan. 30.  Terming the practice “accounting principles made up by management,” Connors argued that non-GAAP “accounting has become increasingly abused with surprisingly little pushback from analysts and investors, effectively penalizing companies hewing to accepted, standardized accounting methods.” 
Corporate incentives driving the propagation of adjusted results are easy enough to understand, as a January paper by Nicholas Guest, assistant accounting professor at Cornell’s Johnson Graduate School of Management, along with co-researchers S.P. Kothari and Robert Pozen of the MIT Sloan School of Management, reaches an arguably intuitive conclusion: 
CEOs of S&P 500 firms that report high non-GAAP earnings relative to GAAP earnings receive substantial unexplained pay. Crucially, this result remains even after controlling for the level of non-GAAP and GAAP earnings. 
Our results are consistent with the managerial power framework of Bebchuk, Fried, and Walker (2002). In their model, all executives have at least some power to extract rents whenever the company lacks a controlling or dominant shareholder to provide discipline. However, outraged boards and dispersed shareholders who recognize rent extraction can impose some constraints.
The trio identified other salient features associated with companies most inclined to tweak their results in an optically pleasing fashion:
Additionally, despite. . . lower GAAP [income] and return performance, these firms are more likely to beat the earnings targets specified in their compensation plans, which likely increases investors’ perceptions of core operating earnings and reduces outrage. Indeed, these firms face less dissent from shareholders and proxy advisors, and no additional media scrutiny.
To wit: Kenneth Broad, co-chair at Jackson Square Partners, pointed out in a Jan. 29 letter to the Financial Times that Salesforce, Inc. reported an 18.7% operating margin over the 12-months ended March 1, 2022 under its home brew, though that figure would shrink to just 2.1% under GAAP. Similarly, 46.3% of reported free cash flow in that fiscal year resulted from the issuance of stock-based compensation expense, while shares outstanding have expanded by a hefty 28.4% over the past three-year period.  Noting that “many of Silicon Valley’s leading firms tout similarly misleading financials,” the investor termed SBC-induced dilution
“the financial equivalent of quicksand from a shareholder value perspective.” 
In the case of Salesforce, shareholders at least have their say, as CEO Marc Benioff holds just under 3% of the outstanding total while the cloud software behemoth issues only a single class of shares.  Yet the proliferation of management-friendly voting structures across the lynchpin technology sector may foment the C-suite largesse highlighted by Guest et al.  
A Feb. 19 paper from law firm Fenwick & West LLP found that 25.5% of the 2022 Fenwick Bloomberg Law Silicon Valley 150 – an index tracking some of the largest names in tech and life sciences – utilized a dual-class voting structure in 2022, up from just 2.9% in 2011.  That increase runs counter to corporate America at large, as the share of S&P 100 firms conferring such super-voting shares on insiders shrunk to 5% last year from 9% in 2011.   
Tellingly, firms that came public during the Covid-era euphoria capitalized on those friendly conditions en masse. A cool 46.6% of the 118 technology IPOs in 2021 sported a dual-class structure, data from University of Florida professor Jay R. Ritter show, while a 23.8% share of the 193 non-tech IPOs opted for the same. 
Recap Feb. 28
Stocks came under late pressure to leave the S&P 500 weaker by 40 basis points, while Treasurys remained largely inert with the two-year yield ticking to 4.81% from 4.78% Monday and the long bond holding at 3.93% for a third straight session. WTI crude climbed towards $77 a barrel, gold rose to $1,834 per ounce and the VIX remained below 21. 
- Philip Grant
Pins and Needles
Fifteen pieces of flair is the minimum.  From the Financial Times
Communist party members at EY China in Beijing have been asked to wear their party badges to show their political loyalty while they are at work. Most of China’s 97 million Communist party members are supposed to wear their party pins at work, but observance is generally higher during politically sensitive times.
EY China is one of the first known examples of a company with international affiliations asking its employees to do the same. “The badge should be placed in the middle of the left chest and cannot be worn on the collar,” said the EY directive. “When worn with other badges, it should be placed above them.”
Ex Officio
They're still standing:
They’re still standing: Commercial real estate in the U.S. has demonstrated impressive resilience considering the virus-induced surge in remote work and dramatic rise in borrowing costs over the past year, Brookfield Asset Management CEO Bruce Flatt told Bloomberg Television last Thursday. “High quality space is very sought after as companies want to bring people back” to the office.
Though a Brookfield property fund recently defaulted on $784 million in loans backing a pair of downtown Los Angeles office towers, the executive sees smoother sailing ahead with an end to the current tightening cycle in sight: “We have seen the worst of it, it hasn’t all transferred to the economy yet, but the worst of the medicine has been doled out,” Flatt said. 
High-level data comport with that optimistic view, for now at least. CMBS secured by office collateral showed a 1.83% delinquency rate in January, data from data firm Trepp show, well above the 1.58% seen in December but still south of the 1.98% rate in force at the end of 2019. 
That figure may be set to rise further in coming months, as Trepp managing director Manus Clancy told The Wall Street Journal last week that five to 10 office towers per month are now joining the ranks of the delinquent, owing to diminished occupancy, expiring leases or maturing debt that would need to be refinanced at far higher rates.  
Demonstrating that dynamic, Columbia Property Trust defaulted Tuesday on a $1.72 billion, floating-rate loan backed by seven office towers in San Francisco, greater NYC and Boston. That portfolio, which was appraised at $2.27 billion in 2021, sports such bold-faced tenants as Snapchat, Twitter and WeWork. “We look forward to a collaborative process [with creditors] yielding thoughtful solutions that reflect market conditions,” a Columbia spokesperson said. 
Ultimately, the problem is a relatively straightforward one, in the estimation of some observers: “The economy built all this office space for a workforce that was going into the office most of the time,” Kevin Thorpe, chief economist at Cushman & Wakefield, told the WSJ. “Most businesses simply don’t need as much office space as they had before.” Average occupancy rates across 10 of the largest U.S. metropolitan areas remains stuck at roughly half its pre-virus baseline per Kastle Systems, which tracks daily data from digital security key swipes. 
CNBC reported Wednesday that Google has instructed employees and contractors within its cloud division to share desk space and alternate in-office workdays to improve “real estate efficiency.” That move will impact staffers in Google’s five largest corporate locations, including New York, San Francisco and Seattle. 
Compounding those adverse market shifts, both secular and cyclical: unfriendly policy changes from revenue-hungry municipalities. Beginning on April 1, the city of Los Angeles will impose a sharply higher transfer tax on commercial and residential real estate transactions of $5 million or more, supplementing the current 0.59% levy with a 4% duty for deals ranging up to $10 million and 5.5% for those priced north of that stepped-up threshold. In other words, a 50%-leveraged owner of a building valued at $10 million or more would see 11% of their equity vanish overnight. Then, too, underwater landlords will receive no relief, as the new tax schedule will apply regardless of whether the property is sold at a gain or loss.
Of course, the City of Angels isn’t alone in putting the screws to developers already under pressure from post-Covid market dynamics. See the current edition of Grant’s Interest Rate Observer dated Feb. 24 for a look at similar dynamics at play in the Big Apple, with potential investment consequences therein. 
Recap Feb. 27
Stocks managed a modest 35 basis point lift on the S&P 500 to recoup a bit of the losses seen last week.  Treasurys likewise finished a bit stronger in the belly of the curve, though two- and 30-year yields each remained at Friday’s closing levels of 4.78% and 3.93%, respectively, while gold edged higher at $1,824 per ounce and WTI crude ticked below $76 a barrel. The VIX settled just south of 21, down three-quarters of a point. 
- Philip Grant
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