David Einhorn bets on US corporate credit as economy slows

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David Einhorn's hedge fund, Greenlight Capital, is betting on US corporate credit, while the slowdown in the economy reveals weaknesses after years of increasing debt from companies, with the result that it calls for increasingly poor protections from investors.

"Corporate debt has increased significantly, while the covenants and protections of other bondholders have weakened considerably," he wrote in a July 25 note. The rating companies – Moody's, Fitch Ratings and Standard & Poor's – have been "complacent," he added, and have not adjusted the ratings badigned to the debt of the companies. businesses as various indicators of financial health deteriorate, such as debt to earnings before interest, taxes, depreciation and amortization, or Ebitda.

"In the meantime, we have been in an economic recovery for a decade and there are signs that the economy could slow down," he wrote.

Einhorn is not alone in his thinking. Debt investors have been worried for years about the deterioration in the quality of the covenants that he mentions, but it's only recently that they've started to organize themselves. to roll back. They spent a large part of 2018 very concerned about the extremely high number of high-quality corporate bonds, a concern that has been the subject of less discussion this year, but remains strong.

Paul Tudor Jones II, founder of the hedge fund Tudor Investment, said last year that the world was plunged into a "global credit bubble," and Jeffrey Gundlach of DoubleLine Capital warned that the corporate bond market was Most important. threat in a debt-dependent economy.

On Friday, the US Department of Commerce will release a first estimate of gross domestic product in the second quarter, which is expected to be less robust than the first quarter, in which the economy grew at an annual rate of 3.1%.

Private sector forecasters expect annual GDP growth of about 1.5% to 2% in the second quarter. The Federal Reserve Bank of New York estimates that real output has risen by 1.4%, while the Atlanta Fed expects 1.6% growth, which would represent a net slowdown from the average 2.9% recorded since the second quarter of 2017.

In addition, writes Einhorn, the additional return required by investors to hold business credit instead of a similar public debt – the "spread" – is approaching historic lows, which reduces "the cost of bets on business credit … rather low.

"The reduction in corporate credit … is a hedge for our long-term equity portfolio," he added.

When asked if this was expressed by credit default swap indices, a spokesman for the company declined to comment.

Other bond investors have expressed concern about "Ebitda buybacks", generous badumptions about future corporate synergies and savings. In 2015, S & P Global reviewed debt repayments issued on leveraged buyouts and leveraged mergers and found that these badumptions inflated EBITDA by an average of 45%.

Over the next two years, 75% or more of these companies missed their forecast additions of 10% or more, show data from S & P Global. In 2017, 30% of its sample missed these forecasts by 50%. And this in the context of strong economic growth, which should not continue.

"The long-term prospects for credit quality improvements in a medium-high-yielding company are limited," Jody Lurie of Janney Montgomery Scott wrote in a July 19 note. "Companies share less optimistic orientations, reduced capital expenditure plans and labor shortages to slow their long-term expansion."

Write to Mary Childs at [email protected]