October 2018 – Cincinnati Asset Management

29 Oct 2018

Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

CAM Investment Grade Weekly
10/26/2018

Amid the backdrop of a volatile equity market, corporate credit spreads are meaningfully wider on the week as we go to print, with credit spreads at least 5 wider across the board. On Friday afternoon, the 10yr Treasury stood at 3.08%, which is 11 basis points lower on the week.

According to Wells Fargo, IG fund flows during the week of October 18-October 24 were -$1.6bln. Per Wells data, this was the fourth consecutive weekly outflow for a cumulative total of -$7.2bln over that time period. IG fund flows are now +$96.342 billion YTD.

According to Bloomberg, new corporate issuance on the week was less than $6bln. This was an underwhelming issuance figure relative to market expectations of $15-20bln, with the weak tone of the market keeping issuers at bay. Issuance for the month of October stands at $75bln while YTD issuance is $971.559bln.

(Bloomberg) AB InBev Cuts Payout in Half as Rising Rates Squeeze Debtors

Anheuser-Busch InBev NV, the world’s largest brewer, cut its dividend in half as it seeks to pay down its $109 billion debt mountain, much of it taken on to acquire rival SABMiller Plc in 2016.
The Budweiser maker justified its move by pointing to the plunge in emerging-market currencies, which is crimping its cash flow. Third-quarter profit missed analysts’ expectations and sales growth slowed to the weakest pace in more than a year. The stock plunged as much as 9.2 percent amid a global selloff.
The most generous dividend-payer in the food-and-beverage industry is pulling back to protect itself as the U.S. Federal Reserve increases borrowing costs. The move comes as a number of payments are increasingly in doubt, including that of General Electric Co. Consumer-goods makers with the highest dividend yields include Kraft Heinz Co. and General Mills Inc. Such debt-laden companies are struggling to reduce leverage amid competition from small upstarts.
AB InBev said the new dividend policy will make it easier to reach its goal of reaching a debt level that’s equivalent to two times earnings before interest, taxes, depreciation and amortization. The brewer may be trying to strengthen its finances in case acquisition opportunities arrive, wrote Nico von Stackelberg, an analyst at Liberum.
“ABI needs a strong balance sheet to have the debt market’s confidence to do big deals,” he wrote, saying it could allow the brewer to bid for assets from the Castel family if they come on the market. Bordeaux-based Castel Group owns beer assets in addition to businesses in wine and soft drinks.
The Budweiser maker will use the entire $4 billion it saves to pay down debt, Chief Financial Officer Felipe Dutra told journalists on a call. AB InBev has $1.5 billion of borrowings maturing this year, $3 billion next year and $6 billion in 2020, he said.

(Bloomberg) Japan’s Insurers Aren’t Hedging Their Foreign Bonds Anymore: RBC

Japanese life insurers are holding more unhedged foreign bonds and their hedge ratios are falling, according to RBC Chief Currency Strategist Adam Cole, supporting his bearish view on the yen.
- Notable participants are Nippon Life, Meiji Yasuda and Mitsui, Cole wrote in note; main exception is Kampo
- The trend was “instrumental in turning us bearish” on the yen and is only becoming “more entrenched”
- Life insurers will ramp up purchases of unhedged bonds when the yen is strong
- RBC sees long-term USD/JPY target of 125; pair traded at ~111.95 as of 9:50am ET
- The desire to cut hedges on existing foreign bonds holding is probably why dips in USD/JPY have been shallow lately, even in severe risk-offs

26 Oct 2018

High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$2.1 billion and year to date flows stand at -$39.6 billion. New issuance for the week was $5.0 billion and year to date HY is at $158.1 billion, which is -30% over the same period last year.

(Bloomberg) High Yield Market Highlights

Junk bond returns took a beating yesterday, with CCCs losing most and yields rising across ratings amid fund outflows, equity volatility and disappointing earnings. This morning’s drop in U.S. equity futures keeps the pressure on.
Junk bond spreads widened and yields rose across the risk spectrum as equities dropped more than 4% mid week and the VIX jumped 27%
Stocks recovered a bit, while VIX remains above 20
October saw the fourth biggest outflow on record and MTD outflow was $5.4b
While high yield investors turned cautious, lack of supply is supportive
This was the slowest October since 2015 with $8.4 billion MTD of issuance
YTD volume at $158b was the lowest since 2009

(Reuters) Leverage rising on US buyout loans after regulation relaxed

Leverage ratios on private equity-backed deals are rising again as banks compete more aggressively for lucrative private equity loans after regulators relaxed leveraged lending guidelines earlier this year.
The guidelines were put in place in 2013 to limit systemic risk and prevent a re-run of the financial crisis, but were relaxed in February
In the first nine months of 2018, the guidelines’ original limit of 6.0 times leverage was exceeded by a record 73.1% of private equity buyout loans, up from 64.2% in 2017. This exceeds the previous peak of the market in 2007 immediately before the financial crisis, when 61.5% of deals were levered at that level, according to LPC data.
“The shackles have been taken off,” a banker said.
Strong investor demand for floating rate leveraged loans is exceeding a limited supply of deals as cash continues to pour into the asset class in a rising interest rate environment. Toppy equity markets mean that private equity firms are paying high enterprise valuations, which is producing more highly leveraged loans as banks compete for mandates.
The most aggressive highly leveraged deals are also setting new records with 41.4% of sponsored deals carrying leverage of more than 7.0 times. This eclipses the market’s previous high in 2007, when 38.5% of deals reached that level.
When the guidelines came into effect in 2013, deals with debt-to-Ebitda leverage ratios of more than 6.0 times received unwelcome extra scrutiny from regulators including the Office of the Comptroller of the Currency, the Federal Reserve and the Federal Deposit Insurance Corp.
Regulated banks were instructed to make sure that all the company’s secured debt, or half of total debt, could be paid down within five to seven years and explain any exceptions on ‘criticized’ deals.
This immediately handed a competitive advantage to institutions not subject to the guidelines, which were able to lead more highly leveraged loans than regulated banks.
That edge disappeared in September, when the Fed and the OCC said the guidelines are not technically rules, following February’s comments by Comptroller of the Currency Joseph Otting that banks could underwrite outside the guidelines as long as they did so prudently and had capital to support it.

(Bloomberg) NeoTract Welcomes UK Government Announcement to Remove Barriers to Adoption of the UroLift® System

A new Government scheme announced today selects the UroLift^®System as one of seven innovations across all specialisms that are the most transformative for NHS patients
The UroLift System will now benefit from support from the Accelerated Access Collaborative to rapidly increase its uptake in the NHS. This enables transformative products to reach patients as quickly as possible through streamlined regulatory and market access decisions.
Neil Barber, Consultant Urologist, Frimley Health NHS Foundation Trust, was the first surgeon to routinely offer the UroLift System on the NHS. Mr. Barber said, “I am very pleased by this news. Having been involved in the initial European randomized clinical trial, the potential benefits of the UroLift System to both patients and the NHS quickly became very clear.

(Bloomberg) At Sell-Off’s Core Is an Earnings Season That’s Consoling No One

A quarter of the way through earnings season and 10 months into what is sure to be the biggest year for profit growth this decade, the numbers are strong. The market doesn’t care.
It sounds astonishing: at a time when S&P 500 operating income is surging more than twice the historical average, stocks have gone nowhere, with both the Dow Jones Industrial Average and S&P 500 erasing their annual gain on Wednesday.
Confidence in the present is quickly becoming panic about the future, as signs of a tottering real estate market, concern about China’s fragile economy and budding indications of inflation blot out optimism that had lifted the S&P 500 almost 10 percent through September. The VIX is at its highest since February.
Aspects of the carnage are different from past corrections. The S&P 500 has declined in 19 of 24 days since peaking in September, with bad days landing at almost twice the frequency of the last three corrections. Unlike earlier selloffs, bulls are fighting the Fed. The central bank has lifted rates eight times since 2015 and given no indication it will let up.
To the extent earnings matter anymore, it’s not this year’s but next year’s, where forecasts for an 11 percent gain are coming under the strictest of scrutiny. Partly it’s the “peak earnings” argument that says the deceleration to roughly half this year’s rate will leave investors with no reason to buy. But it’s also concern that the estimates themselves won’t hold up.

19 Oct 2018

High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.5 billion and year to date flows stand at -$37.5 billion. New issuance for the week was zero and year to date HY is at $153.0 billion, which is -32% over the same period last year.

(Bloomberg) High Yield Market Highlights

Junk bonds yields rose back towards the recent three-month high amid continuing equity volatility and soft oil prices, despite positive fund flow data.
Yesterday, Junk bonds fell 0.23%, the most for a day in more than a week
They were the no new issues for the week
Month-to-date volume is $5.775b, slowest October since 2015
High yield was still the best performer in fixed income with a YTD gain of 1.65%
CCCs beat IG, BBs and single-Bs with 5.16% YTD return, though CCCs also saw the biggest one-day decline in more than a week
IG returns were negative 3.30% YTD

(CNBC) Sears files for bankruptcy, and Eddie Lampert steps down as CEO

Sears Holdings filed for bankruptcy protection early Monday after years of staying afloat through financial maneuvering and relying on billions of CEO Eddie Lampert’s own money. Lampert, who has served as CEO for the past five years, will step down from that post, effective immediately, but remain chairman.
As part of the bankruptcy, Sears will shutter 142 stores toward the end of the year. It expects to begin liquidation sales shortly.
Over the years, Lampert shed Sears assets and spun out real estate to pay down the debt. The company still has roughly 700 stores, which have at times been barren, unstocked by vendors who have lost their trust. Many of the stores have never been visited by younger generations of shoppers.
Lampert, who has a controlling ownership stake in Sears, personally holds some 31 percent of its shares outstanding, according to FactSet. His hedge fund ESL Investments owns about 19 percent.
But even with the bankruptcy filing, Lampert continues to invest in Sears. The retailer said Monday morning ESL is negotiating a $300 million debtor-in-possession loan to support it through its bankruptcy. That loan comes on top of an additional $300 million it has secured from investment banks.
Lampert also expressed regret he couldn’t get the necessary parties to agree to his last efforts to stave off bankruptcy.
The board was in a perilous position. Its special committee had been tasked with approving Lampert’s latest plan, a bid to buy his storied Kenmore appliance business and other brands.
Approving Lampert’s offer would have helped Sears make its payment. But that would also thrust the board into the spotlight, potentially opening them to the threat of litigation from shareholders who might allege Lampert has stripped the business bare.

(CNBC) Talk of a US recession in 2020 is a little premature

Several analysts have come out of the woodwork in the last few weeks predicting not just a U.S. growth slowdown, but the start of a recession in 2020.
Is the fiscally turbocharged U.S. growth about to come to an end? The economy is growing at a robust pace of around 3 percent for 2018 and is set to grow at 2.5 percent in 2019 (according to IMF’s latest world economic outlook): a moderation due to waning fiscal impulse and trade wars. But when does a late cycle economy transition into an economy that’s verging on a recession?
While inflation has been rising, wage growth of sub-3 percent is still far from pre-great financial crisis levels north of 4 percent. In a note published last week, Goldman Sachs Chief U.S. Economist Jan Hatzius remarked that despite the unemployment rate standing the lowest level in 48 years (at 3.7 percent), core personal consumption expenditure (PCE) inflation — the metric the Federal Reserve looks at — has remained steady at around 2 percent.
Rising wages would typically be associated with a squeeze in corporate profits. Perkins calculates that rising wages have been matched by productivity so there hasn’t been a corporate squeeze yet. In fact profit share, as a percentage of gross domestic product, is about 10 percent higher than it was 20 years ago, according to Perkins. Top-line earnings are still growing.
That leaves us with asset valuations. Aggregate global debt continues to climb, U.S. asset prices are about 50 percent higher in aggregate than five years ago. And the market is certainly starting to get a little jittery if last week is anything to go by.
Crucially however, the economy and companies’ revenues are still growing. The labor market is not showing signs of overheating. Therefore, the recession call might be premature.

(MarketWatch) Fresenius Medical Care cuts view as income falls

Fresenius Medical Care cut its targets for 2018, as it reported an 8% fall in third-quarter net income.
According to preliminary figures released late Tuesday, net income at the German company fell 8% and sales decreased 6%.
On the back of the results, Fresenius Medical Care cut its target for net income growth in 2018 to between 11% to 12%, from a previously guided range of between 13% to 15%. It also now expects revenue growth at between 2% to 3%, down from a previous target of between 5% to 7%.
Fresenius said its third-quarter results were affected by weaker-than-expected volumes at its Dialysis Services business and contributions to campaigns in the U.S. opposing state ballot initiatives.

19 Oct 2018

High Yield Quarterly Rich Balestra - Portfolio Manager 0 comment

2018 Q3 High Yield Commentary

In the third quarter of 2018, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was 2.40%. For the year, the Index return was 2.57%. The 10 year US Treasury rate (“10 year”) was mostly range bound during the quarter oscillating between 2.8% and 3.0%. However, around mid-September, the 10 year started moving higher and reached a high of 3.1%. Back in mid-May the 10 year had a similar swing higher reaching 3.1% before moving back down to the 2.8% area. High Yield remains one of the best performing asset classes within fixed income, and CCC and lower rated securities continue to outperform higher quality counterparts. As we have stated many times previously, it is important to note that during 2008 and 2015, CCC rated securities recorded negative returns of 44.35% and 12.11%, respectively. We highlight these returns to point out that with outsized positive returns come outsized possible losses, and the volatility of the CCC rated cohort may not be appropriate for many clients’ risk profile and tolerance levels. During the quarter, the Index option adjusted spread (“OAS”) tightened 47 basis points moving from 363 basis points to 316 basis points. As a reminder, the Index spread broke the multi-year low of 323 basis points set in 2014 by reaching 311 basis points in late January. The longer term low of 233 basis points was reached in 2007. Mid-April 2018 had a low spread of 314 basis points essentially retesting the 311 spread of late January. Importantly, after the January low the OAS touched 369 basis points in February. Additionally, after the April low the OAS touched 372 basis points in May. Within the High Yield Market, opportunities can show up quite rapidly at times. During the third quarter, every quality grouping of the High Yield Market participated in the spread tightening as BB rated securities tightened 47 basis points, B rated securities tightened 60 basis points, and CCC rated securities tightened 14 basis points.

The Consumer Non-Cyclical, Communications, and Transportation sectors were the best performers during the quarter, posting returns of 3.20%, 3.19%, and 3.09%, respectively. On the other hand, Consumer Cyclical, Capital Goods, and Banking were the worst performing sectors, posting returns of 1.50%, -1.86%, and -1.89%, respectively. At the industry level, supermarkets, pharma, wireless, and cable all posted strong returns. The pharma industry (4.48%) posted the highest return. The lowest performing industries during the quarter were retail reits, office reits, lodging, and retailers. The retail reit industry (-0.13%) posted the lowest return.

During the third quarter, the high yield primary market posted $50.8 billion in issuance. Issuance within Financials and Energy was quite strong during the quarter. The 2018 second quarter level of issuance was significantly less than the $72.9 billion posted during the third quarter of 2017. Year to date 2018 issuance has continued at a much slower pace than the strong issuance seen in 2017. The full year issuance for 2017 was $330.1 billion, making 2017 the strongest year of issuance since 2014. Year to date, the 2018 issuance pace is roughly 27% slower than the same measurement period in 2017.

The Federal Reserve held two meetings during Q3 2018. The Federal Funds Target Rate was raised at the September 26th meeting. Reviewing the dot plot from Bloomberg that shows the implied future target rate, the Fed is expected to increase one more time in 2018 and three more times in 2019. However, based off certain trading levels, the market implied policy rate is projected to be lower than current Fed projections.i Some market concern has risen about the yield curve possibly inverting. However, New York Fed President John Williams was quoted “We need to make the right decision based on our analysis of where the economy is and where it’s heading in terms of our dual-mandate goals. If that were to require us to move interest rates up to the point where the yield curve was flat or inverted, that would not be something I would find worrisome on its own.” While the Target Rate increases tend to have a more immediate impact on the short end of the yield curve, yields on intermediate Treasuries increased 20 basis points over the quarter, as the 10-year Treasury yield was at 2.86% on June 30th, and 3.06% at the end of the quarter. The 5-year Treasury increased 21 basis points over the quarter, moving from 2.74% on June 30th, to 2.95% at the end of the quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. Inflation as measured by core CPI has been moving steadily higher during 2018 from 1.8% to 2.2% as of the September 13th report. The revised second quarter GDP print was 4.2% (QoQ annualized rate). While this print undoubtedly contained some transitory factors due to tax reform, the average of the last four GDP prints stands at a solid 3.08%. The consensus view of most economists suggests a GDP for 2018 in the upper 2% range with inflation expectations at or above 2%.

A major theme in the third quarter was US trade negotiations. As stated in our previous commentary, trade remains a risk as the global status quo continues to be shaken up. At the end of August, the North American Free Trade Agreement (“NAFTA”) revamp was making headlines. The United States and Mexico had reached a new agreement but, at the time, an agreement could not be reached with Canada. Many business leaders and members of Congress made clear that Canada must be part of the equation going forward.ii Canada finally reached an agreement on the new US- Mexico-Canada Agreement (“USMCA”) just before the deadline at midnight on September 30th.iii While the USMCA negotiations are winding down, the trade negotiation with China is heating up. The United States has imposed tariffs on Chinese goods and China has responded with their own retaliatory tariffs.iv At this juncture, the economic impact is small but the risk of escalation is present and must be monitored.

Being a more conservative asset manager, Cincinnati Asset Management remains significantly underweight CCC and lower rated securities. For the third quarter, the focus on higher quality credits did bear fruit, but not enough to overcome the riskiest segment of the High Yield Market. While the CCC segment had only 14 basis points of spread tightening, the superior return was driven by a lower duration and higher coupon relative to the other rating categories within high yield. Our third quarter High Yield Composite gross total return under-performed the return of the Bloomberg Barclays US Corporate High Yield Index (2.09% versus 2.40%). Our underweight in the energy sector and the pharmaceuticals industry were a drag on our performance. Additionally, our credit selections with the consumer cyclical industries of services and leisure hurt performance. However, our overweight in the consumer non‐cyclical sector was a bright spot. Additionally, our credit selections within the midstream industry, capital goods sector, and other industrial sector were a benefit to performance.

The Bloomberg Barclays US Corporate High Yield Index ended the second quarter with a yield of 6.24%. This yield is an average that is barbelled by the CCC rated cohort yielding 8.87% and a BB rated slice yielding 5.14%. While the yield of 6.24% is down a bit from the 6.49% of last quarter, it is up nicely from the 5.44% of Q3 2017. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index, has continued its downtrend from the first quarter of this year. High Yield default volume was very low during the third quarter. In fact, the default volume for the quarter was the second lowest quarterly total since Q4 2013. The twelve month default rate was 2.02% and only 1.29% when iHeart Communications is excluded from the total.v The current default rate remains significantly below the historical average. Additionally, fundamentals of high yield companies continue to be generally solid. Finally, from a technical perspective, supply remains low and rising stars are outnumbering falling angels by a wide margin. This positive backdrop is likely to provide support for the market especially as sizeable coupon payment demand begins to kick in towards the end of the year. Due to the historically below average default rates and the higher income available in the High Yield market, it is still an area of select opportunity relative to other fixed income products.

Over the near term, we plan to remain rather selective. When the riskiest end of the High Yield market begins to break down, our clients should accrue the benefit of our positioning in the higher quality segments of the market. The market needs to be carefully monitored to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. It is important to focus on credit research and buy bonds of corporations that can withstand economic headwinds and also enjoy improved credit metrics in a stable to improving economy. As always, we will continue our search for value and adjust positions as we uncover compelling situations.

See Accompanying Endnotes

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include
reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

i Bloomberg September 19, 2018: “Bond Traders Move Closer to Fed”
ii New York Times August 27, 2018: “Trump Reaches Revised Deal With Mexico”
iii CNN October 1, 2018: “US and Canada reach deal on NAFTA”
iv Bloomberg September 18, 2018: “China Strikes $60 Billion of U.S. Goods in Growing Trade War”
v JP Morgan October 1,, 2018: “Default Monitor”

19 Oct 2018

Investment Grade Quarterly Josh Adams - Portfolio Manager 0 comment

Q3 2018 Investment Grade Commentary

The theme of the third quarter was tighter spreads and higher rates. The spread on the Bloomberg Barclays US Corporate Index started the quarter at a year-to-date high of 124, at which point spreads began to march tighter, with the index finishing the quarter at an OAS of 106. The 10yr Treasury started the quarter at 2.86% before finishing at 3.06%. All told, movements in spreads and rates were nearly a wash, as the 18 basis point tightening of the index was not quite enough to offset a 20 basis point rise in the 10yr Treasury. It was a “coupon-like” type of return for corporate bonds during the quarter as the US Corporate Index posted a positive quarterly total return of +0.97%. This compares to CAM’s gross quarterly return of +0.84%. Through the first 9 months of the year, the US Corporate Index has posted a -2.33% total return, while CAM’s gross total return was -2.13%.

There was a flight to quality in the second quarter that was beneficial to CAM, but that trend reversed in the third quarter. Recall that CAM limits itself to a 30% weighting in BBB-rated credit, which is the lower tier of credit quality within the US Corporate Index, while the index itself had a 49.13% weighting in BBB-rated credit at the end of the third quarter. The BBB-rated portion of the index saw its spread tighten 22 basis points during the quarter, which was 5 basis points better than the 17 basis points of tightening that the A-rated portion of the index experienced. Because CAM targets a 70% weighting in higher quality credit, the gross performance of CAM’s portfolio trailed the index by 0.13% during the quarter. We at CAM are perfectly comfortable, even enthused, by our underweight in lower quality credit. CAM was founded in 1989, so we have seen each of the last three credit cycle downturns that have occurred in the past 30 years. We do not know when the current cycle will turn but we do know that we are 10+ years into the expansion period, and we also know that it is inevitable that the cycle will turn at some point. Most of all, we are not currently seeing enough value in the lower tier of investment grade rated credit. As a bottom up manager that is focused on fundamental research, we are currently finding enough good ideas to populate portfolios, but certainly not enough good ideas to approximate the 50% index weighting in BBB-rated credit. We intend to continue to keep our structural underweight on the riskier portions of the investment grade rated universe and we expect that by doing so that our client portfolios will experience lower volatility and higher returns over the long term.

Yields in the riskiest portions of the corporate bond market may not be currently providing enough compensation for investors (see chart below). On September 19th 2018, the spread between the US Corporate Index and US High Yield Index reached a multi-year low of 207 basis points. This means investors were being compensated just an extra 2.07% to own high yield bonds versus investment grade bonds. This differential finished the quarter at 2.10%, not far off the lows. To put this into perspective, the premium afforded by high yield bonds was as high as 6.25% as recently as February 11, 2016. September 2018 marks the lowest spread between high yield and investment grade since July of 2007, which was just prior to the 2007-2008 credit cycle downturn. Again, we feel like there are certainly some risks worth taking in credit, but there are not so many good investments available that the riskiest portions of the corporate bond universe should be trading at near historical lows relative to the much less riskier portions.

The Federal Reserve raised the Fed Funds Target Rate at its September meeting. This marks the 8th increase in the target since the current tightening cycle began in December of 2015. The current implied probability of a Fed rate hike at the December 2018 meeting is 70.1%i. Fed policymaker forecasts envision short term rates at 3.1% by the end of 2019 which implies a hike in December of this year and two additional hikes throughout 2019ii. In our second quarter commentary, we wrote extensively about the flattening of the Treasury curve relative to the steepness of the corporate credit curve. Our positioning has not changed, and we intend to continue to position the portfolio in intermediate maturities that mature within 5-10 years. We believe that, over the medium and longer term, investors are most appropriately compensated for credit risk and interest rate risk by investing in intermediate maturities and that is largely due to the historically reliable steepness of the corporate credit curve. We are also firm in our belief that investors should spend time focusing on risks that can be managed, like credit risk, and spend far less time trying to tactically reallocate their portfolios in response to risks that are fraught with unpredictability, like interest rate risk.

As we look toward the fourth quarter, we expect a relatively sanguine environment for investment grade credit spreads. Companies should continue to reap the benefits of tax reform and a healthy macroeconomic backdrop for the next few quarters. According to data compiled by FactSet, corporate earnings for the second quarter of 2018 featured the highest number of S&P 500 companies reporting earnings per share above consensus estimates since the data first began being tracked in the third quarter of 2008iii. We expect that earnings in the 3rd and 4th quarters will also be strong, but at some point they will be unable to keep pace with the strength of prior quarters and we wonder how investors will respond. The fourth quarter brings with it far more questions than answers. Will the Fed continue its tightening path in December, and if so, can the economy shoulder the burden of Treasury rates that have the potential to go higher? What surprises are in store for the markets regarding global trade

policy? We are in the midst of the longest economic expansion on record – just how long can it continue? We believe that there are plenty of opportunities in investment grade credit, but that now is the time for prudent risk taking and preservation of capital, which are cornerstones of our strategy. Although investment grade credit has seen negative returns for the first 9 months of the year, we support the thesis that the asset class can be part of the bedrock in the framework of an overall asset allocation and can offer attractive risk adjusted returns over medium and longer term time horizons. As the saying goes, “failing to prepare is preparing to fail”, and now is a time for de-risking bond portfolios instead of being unduly concerned with missing out on upside.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

i Bloomberg 10/1/2018 3:53pm EDT ii FRED Economic Data, FOMC Summary of Economic Projections for the Fed Funds Rate, Median, 10/1/2018 iii FactSet, September 7th 2018, “Record‐High Percentage of S&P 500 Companies Beat EPS Estimates For Q2”

09 Oct 2018

High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $2.3 billion and year to date flows stand at -$34.0 billion. New issuance for the week was $4.7 billion and year to date HY is at $151.7 billion, which is -27% over the same period last year.

(Bloomberg) High Yield Market Highlights

The lowest-rated junk bonds came under pressure, with CCC-rated debt yields hitting a six-month high, as global bond markets sold off. The spread on the Bloomberg Barclays High Yield Index meanwhile hit a fresh 11-year low.
Triple-C yield jumped to almost 9.3% after the biggest rise in more than seven years
Treasury moves and drifting stocks pressured junk bonds across ratings, rate-sensitive BBs and single-Bs were hit hardest
Stocks lost steam amid concerns that Fed hikes, coupled with WTI at a new multi-year high, may cause economic slowdown
Lack of supply continued, with just Covanta Holding pricing a $400m 8NC3 offering at the tight end of talk after receiving orders of more than $1b
Junk bond spreads dropped to new lows as the 5Y and 10Y Treasury yields hit a fresh multi-year high yesterday

(Digitimes) HDD demand for enterprise data centers remains robust, says WD executive

HDD demand for enterprise data centers continues to be strong, according to Christopher Bergey, executive VP at Western Digital (WD).
In the enterprise data center segment, HDD demand has as high as 40% annual growth, Bergey said. There is still a gap between SSD and HDD prices, though the industry’s transition to 3D NAND manufacturing has been dragging down SSD prices, Bergey indicated.
Traditional hard drive storage is well suited for handling massive big data analytics to support machine learning, while solid state storage provides fast read and write speeds to allow fast and efficient decision making, Bergey said.
Bergey continued that it is difficult to assume SSDs will completely replace HDDs given that the latter has its lower cost per unit storage. While SSDs are set to become a broadly use storage technology, the market for HDDs will become more condensed, Bergey suggested.
WD is also a SSD provider. Sales of both the company’s SSD and HDD lines continue their growth momentum, Bergey said.

(CNBC) DaVita shares rise after California bill capping dialysis payments is vetoed

Shares of dialysis clinic operator DaVita rose more than 3 percent on Monday after California’s governor vetoed a bill that would have cut into its sales.
The bill, which was vetoed by Gov. Jerry Brown on Sunday, would have limited reimbursements for financial assistance to dialysis patients. That assistance is used by companies to maximize their reimbursements and can drive up premium costs.
CEO Javier Rodriguez said in a statement the bill “would have harmed thousands of dialysis patients in California by allowing health plans to discriminate against low-income dialysis patients who rely on charitable assistance to pay their insurance premiums.” He also noted the company was “deeply relieved” the bill was vetoed.
Though this is seemingly a win for DaVita, one of the largest kidney care provider in the U.S., but it all depends on what happens next month. California voters will have a chance to vote on a ballot that would limit how much revenue dialysis providers can earn from commercially insured individuals.

(Bloomberg) Sky High Valuations in CCC Bonds

Although the riskiest U.S. corporate bonds have been a great bet this year, some money managers think high valuations mean it’s finally time to sell.
Company bonds that are the most likely to default, rated in the CCC tier, have gained more than 6% this year including interest, while the rest of the junk-bond universe is up just 2.2%. But Bank of America analysts recently warned that the riskiest junk bonds seem to be losing momentum, and investors should consider switching into safer securities.
Bank of America strategists led by Oleg Melentyev advised investors last week to trim their exposure to CCC debt, saying that most of the bonds’ gains relative to higher-rated speculative-grade debt occurred in the first half of the year. The current extra return investors are getting to hold the notes isn’t “the right level of compensation for the amount of credit risk investors are taking,” they wrote.

(Bloomberg) Teleflex Buys Essential Medical; Terms Not Disclosed

Teleflex says it acquired privately-held Essential Medical Inc., developer of the “Manta” device.
Company sees deal modestly adding to constant currency revenue growth and gross margins over multi-year period after the anticipated FDA premarket approval of the Manta device in 2019
Device “specifically designed for closure of large bore arteriotomies following procedures utilizing devices or sheaths ranging in size from 10F to 18F (with maximum outer diameters up to 25F)”

(Business Wire) Arconic Announces Sale of Its Texarkana, Texas, Rolling Mill

Arconic announced today that it has reached an agreement to sell its Texarkana, Texas rolling mill to Ta Chen International, Inc., a U.S. subsidiary of aluminum and stainless steel distributor Ta Chen Stainless Pipe Co., Ltd. Under the terms of the transaction, Arconic will sell Texarkana for approximately $300 million in cash, plus additional contingent consideration of up to $50 million. The transaction is expected to close in the fourth quarter of 2018, subject to receipt of certain regulatory approvals and other customary closing conditions. The Company expects to record a gain on the sale.

01 Oct 2018

High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$1.3 billion and year to date flows stand at -$36.4 billion. New issuance for the week was $4.0 billion and year to date HY is at $146.6 billion, which is -27% over the same period last year.

(Bloomberg) High Yield Market Highlights

Junk bonds are leading the fixed income pack with a near 2.5 percent return at the end of third quarter, shrugging off fund outflows as issuance remains sparse.
U.S. corporate high-yield funds saw a $1.3b outflow for the week ended September 26, biggest outflow in more than 10 weeks
CCCs are the best performing asset in fixed income with YTD return of 5.88%
Investors appeared wary of aggressive LBO funding after Refinitiv and AkzoNobel, as Envision Healthcare’s $1.625b senior notes offering to fund its buyout by KKR was met with resistance to loose covenants, forcing a cut in the size of the offering by $400m and moving funds to term loan
Besides issuer-friendly covenants, Envision was weighed down by stalled negotiations with UnitedHealthcare as it threatened to drop the firm from its network
YTD supply of $147b is the slowest since 2009

(Company Release) CenturyLink Chief Financial Officer Sunit Patel to depart company

CenturyLink announced that Executive Vice President and Chief Financial Officer Sunit Patel has resigned from CenturyLink after accepting an executive leadership role at another company. Patel’s resignation is effective Sept. 28. CenturyLink will initiate a search process for his replacement that will include both internal and external candidates.
Neel Dev, CenturyLink’s group vice president of finance, has been named interim CFO effective upon Patel’s departure. Dev served as the integration planning lead for Level 3 in the recent CenturyLink acquisition and currently has responsibility for business unit finance support, supply chain and procurement, capital governance management, budgeting and financial performance analysis and management. He has been part of Patel’s leadership team for 14 years and has more than 20 years of experience in the telecommunications industry, in both financial and operational roles.
“Sunit has made significant contributions to CenturyLink and Level 3 as CFO, and he has been a valuable partner to both companies and to me,” said Jeff Storey, president and chief executive officer of CenturyLink. “Additionally, Sunit did a great job in building bench strength and an excellent leadership team across the finance organization. As Sunit focused on our external stakeholders, Neel has been our de facto operational CFO and part of my management team for the past ten years. I am highly confident he will continue our drumbeat of financial discipline across CenturyLink with a focus on synergy attainment, operating efficiency and profitable growth.”

(Company Release) CyrusOne Inc. Prices Public Offering of Common Stock

CyrusOne announced that it has priced a public offering of 8,000,000 shares of its common stock, of which 5,500,000 shares were offered directly by CyrusOne, and 2,500,000 shares were offered, at the request of CyrusOne, by the Forward Purchaser, at a price to the public of $62.00 per share. CyrusOne granted the underwriters an option to purchase up to 1,200,000 additional shares of its common stock in connection with the offering.
In connection with the offering of CyrusOne’s common stock, CyrusOne entered into a forward sale agreement with Morgan Stanley (who is referred to in such capacity as the “Forward Purchaser”), with respect to 2,500,000 shares of CyrusOne’s common stock covered by the offering.
Pursuant to the terms of the forward sale agreement, and subject to CyrusOne’s right to elect cash or net share settlement under the forward sale agreement, CyrusOne intends to issue and sell, upon physical settlement of such forward sale agreement, 2,500,000 shares of its common stock to the Forward Purchaser in exchange for cash proceeds per share equal to the applicable forward sale price, which will initially be the public offering price, less underwriting discounts and commissions, and will be subject to certain adjustments as provided in the forward sale agreement. CyrusOne expects to physically settle the forward sale agreement in full and receive proceeds by September 15, 2019.
The Operating Partnership intends to use such proceeds to repay borrowings under the senior unsecured revolving credit facility, fund growth capital expenditures related to recently signed leases and for general corporate purposes, which may include funding future acquisitions, investments or capital expenditures.

(CAM Note) On the back of the stock issuance, S&P upgraded the debt of CyrusOne by one notch. The debt is now investment grade at S&P.

(CNBC) Health Management Associates to pay $260 million to settle criminal charges for allegedly defrauding Medicare, Medicaid

Health Management Associates has agreed to pay more than $260 million to settle fraud charges that included paying kickbacks to physicians and ripping off federal health programs, the Justice Department said.
HMA, which was acquired by the for-profit hospital Community Health Systems in 2014, paid physicians in exchange for patient referrals and submitted inflated claims for emergency department fees to federal health insurance programs, prosecutors said.
The agreement announced Tuesday also resolves several outstanding civil claims against the hospital operator, the DOJ said. An HMA subsidiary that operated under the name Carlisle Regional Medical Center additionally agreed to plead guilty to one count of conspiracy to commit health-care fraud.
“HMA pressured emergency room physicians, including through threats of termination, to increase the number of inpatient admissions from emergency departments — even when those admissions were medically unnecessary,” Assistant Attorney General Brian Benczkowski said in a statement. “Hospital operators that improperly influence a physician’s medical decision-making in pursuit of profits do so at their own peril.”

01 Oct 2018

Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

CAM Investment Grade Weekly
09/28/2018

Corporate credit spreads are largely unchanged on the week. As expected, the Fed increased the Federal Funds Target Rate by 25 basis points on Thursday to an upper bound of 2.25%. This was the third rate hike of 2018 and the 8^th increase in the current tightening cycle which began in December of 2015. Notably, the 10yr Treasury has trended modestly lower on the back of the Fed announcement –it was as high as 3.07% at noon on Thursday but today it is at 3.04% as we go to print.

According to Wells Fargo, IG fund flows decelerated once again during the week of September 20-September 26 and were +$779 million during the week. IG fund flows are now +$97.141 billion YTD.

According to Bloomberg, issuance on the week is going to come in at $12.7bln, as there is a small deal pending this Friday morning. This brings the September new issuance tally to $122.9bln and the YTD tally to over $895bn. September has now passed January as the month with the most issuance so far in 2018.

(Bloomberg) Why Comcast Is Paying Dearly for Britain’s Sky

Pay-TV subscriptions are still growing in Europe, and Comcast’s $39 billion purchase of Sky Plc gives it global reach.
The Sky deal would propel Comcast’s debt to at least $100 billion, placing the company among a small group that have borrowed that much, including AT&T Inc., which in June closed on its $85 billion purchase of Time Warner Inc. The debt could go even higher now that Fox on Sept. 26 said it will sell Comcast its 39 percent stake in Sky, worth more than $15 billion—a decision that required approval from Walt Disney Co., which is buying most of Fox.
Comcast executives say they’re confident they can generate enough cash flow to pay down their debt over time. For now, the company’s credit ratings are unchanged, though an S&P Global Ratings analyst has given it a negative outlook. But the success of the deal depends on continued strength at its U.S. business and the combined TV giants fending off the global rise of streaming rivals Netflix Inc. and Amazon.com Inc.
Sky is essentially Comcast’s European twin, with about 23 million customers, mostly in the U.K. and Ireland. With Sky, the U.S. company would almost double its customer base. Like Comcast and its X1, Sky sells a box called Sky Q, which has a slick interface that makes it easier to find what to watch—and provides a rich source of data on customer viewing habits. Unlike Comcast, Sky is still gaining video customers.
The two companies could benefit from being under the same roof. For instance, Comcast and Sky could have their studios team up to create more original TV shows for Sky’s online service. That could provide a bulwark against the rise of Netflix, Amazon, and Home Box Office Inc., which are spending billions of dollars in a global race for online TV customers, especially in Europe. Perhaps most important, as more Americans drop their cable-TV subscriptions, Sky offers Comcast a foothold on a continent where cord-cutting hasn’t taken off yet.

(Bloomberg) Abbott Laboratories EU3.42b Debt Offering in 3 Parts

Use Of Proceeds: To repay all or portions of Abbott’s outstanding 2.00% notes due 2020, 4.125% notes due 2020, 3.25% notes due 2023, 3.4% notes due 2023, and 3.75% notes due 2026, and for fees, expenses, and other costs associated therewith
CAM Comment: According to BVAL the OAS on ABT 3.75% 2026 has tightened 25bps in the month of September 2018

(Bloomberg) All four of the Vogtle 3 & 4 co-owners vote to move forward with construction of nuclear expansion project

All four of the Vogtle 3 & 4 project co-owners (Georgia Power, Oglethorpe Power, MEAG Power and Dalton Utilities) have voted to continue construction of the two new nuclear units near Waynesboro, Ga.
The new units are the first to be built in the United States in more than 30 years and the only new nuclear units currently under construction in America. Expected on-line in November 2021 (Unit 3) and November 2022 (Unit 4), the new units are expected to generate enough emission-free electricity to power approximately 500,000 homes and businesses.

(Bloomberg) AerCap takes Delivery of its First Boeing 737 MAX

AerCap Holdings N.V. has today announced that it has taken delivery of its first 737 MAX 8. The aircraft will be leased to China Southern Airlines, the first of 5 aircraft to go on lease to the airline from AerCap’s 737 MAX order book with Boeing.
AerCap has a total of 104 Boeing 737 MAX aircraft owned and on order, delivering through 2022.

(Bloomberg) Bill Ford Sees No Crisis While Fitch Warns of Challenging Times

Ford Motor Co. has work to do to reverse its declining fortunes but isn’t a company in crisis, Executive Chairman Bill Ford said Thursday, while the Fitch Ratings service warned of challenging times ahead for the automaker.
“I don’t think it’s even close to a crisis — we’re making good profitability,” Ford told reporters at a centennial celebration of the company’s Rouge manufacturing complex near its headquarters in Dearborn, Michigan. “Do we still have work to do? Yes, we do. But we are investing heavily in the product. We’re investing heavily in the future. And there’s nothing that we want to do that we can’t do.”
Fitch Ratings today warned of risks Ford faces in its $11 billion restructuring, which the automaker said could take five years. Moody’s Investor Service lowered Ford’s credit rating last month to one notch above junk on concerns about executing that overhaul.
“The company has entered a challenging period, despite a strong liquidity position,” Stephen Brown, Fitch senior director, wrote in a note on Ford. “With the recent cost pressures, there is less headroom in the ratings, which heightens the potential for a negative rating action if it appears the transformation program is not meeting expected milestones.”