The Covid-19 crisis has had a huge impact on every area of the bond market - crushing earnings, straining balance sheets and increasing credit risk. Alongside this has come large-scale state intervention and a wave of new bond issuance.
One name that seems to exemplify all these developments is Ford. It is facing unprecedented disruption to its production and its markets. It has had to shore up its balance sheet in the face of scepticism from the rating agencies. It has come to the bond market and, in doing so, it has offered an interesting investment opportunity that I have sought to exploit in Invesco Enhanced Income Ltd and City Merchants High Yield Trust.
Automobile manufacturing is, of course, a cyclical business. Sales have fallen with every spike in unemployment since Wards began publishing their US Light Vehicle Sales updates in 1976. They fell at an annual rate of more than 30% in 2009, when new jobless claims in the US were running about 600,000 per week. In the last five weeks, US jobless claims have averaged no less than 5.3m.
Operationally, this is the worst period in Ford’s history. It has an estimated cash burn rate of $800m per week, an amazing number that shows what happens when a huge manufacturer like this suddenly stops working. At the worst point in the last recession, in Q4 2008, cash burn was $640m per week.
Ford has dealt with lots of challenges in the last couple of decades – being downgraded to high yield in 2005 and coming near bankruptcy in 2006. It has learnt from experience and it came into this crisis with $30bn of liquidity on its balance sheet. The decision it has taken to suspend its dividend will free up as much as $2bn more in 2020. But even that provides only so much cushion with an estimated cash burn of $10bn in the second quarter. Cash from working capital will return to the business as soon as sales begin to rise but when that happens is uncertain.
The challenges facing Ford have already had a ratings impact. On the 25th of March, S&P downgraded the credit to BB+. That also moved the composite rating to BB+ and meant that Ford was officially junked. The difficulties of fallen angels and the impact they have on the wider high yield market has been a major story in the bond markets for years, one already back in the spotlight after the fall of Kraft Heinz and Macy’s in February.
The impact of adding Ford’s $36bn of debt to the high yield market now is much smaller than when GM and Ford both fell into a then much smaller high yield market in 2005. But Ford has a big chunk of its total debt maturing in the next five years and there are very likely to be other angels falling before this crisis is over. Financing a company of this size from the high yield market could be difficult.
However, Ford will be helped as part of the huge response by the authorities to this crisis. The Fed was quick to commit to direct support of the corporate sector through loans and purchases of corporate bonds in the secondary market. The initial support packages stipulated that investment would be in investment grade bonds but on the 9th of April these packages were increased and eligibility criteria were relaxed to include issuers “. . . rated at least BBB-/Baa3 as of March 22, 2020 . . .”. So Ford squeaks into the remit of this $750bn programme by three days. It is hard to believe that the company was not in the Fed’s thinking when it made this adjustment. To my mind, this move put to rest any real concerns about Ford’s access to capital in the near-term.
Ford came to the market the following week, initially looking to raise $3bn across three, five and ten year bonds. Initial indications on coupons were 9.5%, 10% and 11%. Meeting with a very positive market, the deal was upsized to $8bn, with lower coupons and split as follows:
Source: Bloomberg as at 30 April 2020.
The book size for the deal was reported at a staggering $40bn, meaning that the average investor was allocated just 20% of what they committed to purchase.
In the circumstances, this was a great success for Ford. On the other hand, Ford has had to pay a painful rate of interest. As recently as November, they issued a 5-year USD bond with a coupon of 3.95%.
The terms of these bonds were good enough for me to want to add them to the City Merchants High Yield Trust and Invesco Enhanced Income Ltd as well as recommending them to the rest of the desk. In my opinion, the new capital goes a long way to shoring up Ford’s balance sheet for the medium term. The company does not need the economy or auto sales to recover all the way to 2019 levels. Even a small improvement in sales volume will see cash flowing back in and the credit story improve.
Ford may now be a high yield credit, but I believe it remains an extremely strong, global brand. I think the risk is acceptable. In return I am receiving income at a rate that I think will be advantageous to my portfolios and my clients. Government bond yields are at, near or below zero in the major economies. A judicious allocation to credit risk, in return for a substantially higher level of income, is going to be vital for investors. I think Ford’s bonds are a step towards that.
The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.
The portfolio’s have a significant proportion of high-yielding bonds, which are of lower credit quality and may result in large fluctuations in the NAV of the product. The product uses derivatives for efficient portfolio management which may result in increased volatility in the NAV. The use of borrowings may increase the volatility of the NAV and may reduce returns when asset values fall. The product may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events.
All data is as at 30/04/2020 and sourced from Invesco unless otherwise stated.
Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.
For more information on our products, please refer to the relevant Key Information Document (KID), Alternative Investment Fund Managers Directive document (AIFMD), and the latest Annual or Half-Yearly Financial Reports.