The Daily Update - Not so noble

According to rating agency Fitch, Noble Group Ltd., Asia’s largest supply chain manager is at risk of defaulting. Headquartered in Hong Kong, Noble is involved in sourcing, storing, transporting and distribution of agricultural, energy and industrial products. Fitch last week slashed Noble's already junk rating two notches to CCC, stating that the company faces ‘substantial credit risk’, adding ‘default is a real possibility’.

We have previously held Noble, via the 6.75% 2020 bond for example; we added the holding back in October 2011 at a price of $98.50 and spread around 515bps over Treasuries. The bond was trading over 2.5 notches cheap and had an expected return of around 11% and yield just under 7%, which we felt was attractive at the time. We closed the position in September 2014 at a near all-time high price of $112.15, a ~290bps tightening in spread. The bond was rated Baa3 by all three major rating agencies; i.e. the highest rating the bond has ever been granted.

We started selling out of our holdings from mid-2014 after our credit research highlighted that the company’s fundamentals had started to crumble, and the lack of company account information proved difficult to ascertain just how bad the situation was. This coupled with its second largest investor, China investment Corp, (the sovereign wealth fund) slicing its ownership in the company in September 2014 was a clear sell signal. Rating agencies were slower to react however, with Moody’s downgrading the bond to junk at the end of 2015, with three notches of downgrade during the following year. Meanwhile Standard and Poor’s waited as long as 2016 to downgrade the company’s rating to sub-investment grade, followed by Fitch’s move to cut later on in 2016.

Once out of our position, we saw all manner of bad news regarding Noble hit the newswires: the tumble in commodity prices for example had led to a huge loss in the final quarter of 2014, with sales falling almost 15%, and a number of questions arose regarding the company’s accounting practises. Needless to say the price of the bond collapsed to around $42 by the middle of January 2016. It pared losses following the bounce in commodities rallying to just under par, and since the beginning of May has plummeted to an all-time low ~$36, or spread of +5000 over; not helped by the announcement by Fitch. This bond is obviously very cheap now, we calculate an expected return in excess of 75%, yield of 52% and 12 notches of credit cushion; however, even if we could add it to the small high-yield factor on our Next Generation Bond Fund, we wouldn’t touch it with a bargepole.

Fundamentals vary widely between countries and companies across the globe, which is why we assess each separately. We use our proprietary NFA scoring system, Relative Value Model and credit analysis tools, amongst others, to first eliminate ‘risky’ bonds. We therefore believe all the bonds within our investable universe have good fundamentals, thus we have never experienced a bond default in our portfolios.

The long-term average default rate for sub-investment grade credit globally is around 4%, and default adjusted returns for junk bonds are likely to come under pressure as the Fed tightens and global growth remains subdued. We believe that the current economic environment, which is one of high debt and slow growth is a poor combination for investors in junk bonds; which is why we currently own only investment grade credit  across our portfolios.

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