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Major U.S. investment banks are taking sharp losses on bond issues agreed to before the U.S. Federal Reserve began raising interest rates, the Financial Times reported.
When banks structure bond issues, they specify the maximum interest rate the bonds will pay, with a little wiggle room included—usually around 5 percent—in case markets move.
However, since several recent deals were closed, Russia invaded Ukraine, the global economy has hit the brakes, inflation has risen further, central banks have stopped buying bonds, and the U.S. Federal Reserve has raised interest rates higher and faster than expected, the FT noted.
As a result, investors are demanding lower prices and higher yields to compensate them for the added risks they take by buying the bonds.
In response, banks have dropped bond prices, which cuts into their fees for structuring and managing the bond sales.
“Almost every single deal that was underwritten will have to come at a discount and underwriters are having to pay for it,” an unnamed U.S. banker told the FT.
When underwriting banks have to discount bonds, they eat the loss. When discounts fall below 95 cents on the dollar, those losses begin to mount quickly.
Intertape Polymer, a packaging corporation with a poor credit rating, borrowed $400 million in mid-June and had to offer 10 percent interest, the top rate specified in the bond issue.
Still, there were few takers and underwriter Deutsche Bank had to drop the bond price by 18 percent, booking a loss of around $50 million for itself and Bank of Montreal, Credit Suisse, Golub Capital, and Jeffries, its other partners in the bond issue.
The Intertape fiasco was only the sixth bond issue since 2008 to have to drop to, or below, 82 cents on the dollar, the FT said.
Also this month, an $895-million bond issue led by Morgan Stanley for chip-maker Entegris sported a 5.95-percent interest rate, the highest included in the deal when it was structured late last year, the FT said.
To move the bonds, the underwriters had to drop the price below 92 cents on the dollar.
Barclays, Bank of America, PNC, Truist, and Wells Fargo shared a $35-million loss with Morgan Stanley.
ICE Data Services’ index of high-yield bond prices – junk-grade issues – has fallen 13 percent so far this year.
TREND FORECAST: The situation will worsen as central banks keep raising interest rates to slow inflation… which will continue to stay high as the Ukraine War and the sanctions the United States, NATO and its allies have imposed on Russia keeps pushing food and fuel prices higher.