Friday February 17

Stocks rose today after starting off the day on a hesitant note. The S&P 500 rose 0.2% to 2,351 while the Dow Jones was little changed at 20,624. This marked the seventh consecutive day of gains for the Dow. Over the course of the week the S&P 500 and the Dow were 1.5% and 1.7% higher respectively. Today the KBW Bank index fell 0.2% while utilities rose 0.2%. The economic calendar today was light. The two year Treasury yield fell 2bp to 1.19%. The ten year Treasury yield fell 3bp to 2.42%. Accordingly 2yr vs 10yr bull flattened to 1.23%. Over the course of the week the 2 and 10 year were flat and 1bp higher respectively. The dollar was mixed on the day against peers. USD rose 0.5% against EUR to $1.0616. USD rose 0.5% against GBP to $1.2422. USD fell 0.3% against JPY to Y112.88. Oil prices were for the most part flat on the day. WTI rose less than 0.1% to $53.38 and Brent added 0.2% to $55.75.

Kraft approached Unilever for a $143bn acquisition however Unilever turned down the approach. Kraft says that even though this deal was shot down it will continue to explore options related to acquiring Unilever and they hope to reach an agreement. Unilever said that the deal totaled $50 a share in the form of both cash and equity shares for an all in valuation of $143bn. That represents an 18% premium to Thursday’s closing price and Unilever turned it down because they believe that the valuation is too low. Unilever trades in London and its share price rose 12.2% to reach a market cap of $139bn. Kraft also rose more than 7% on the news. Kraft will have until March 17 to make another offer. Kraft owns the rights to Heinz, Oscar Mayer, Planters peanuts, Philadelphia cream cheese, Maxwell House coffee among others. Unilever owns Hellmann’s, Lipton, and Ben & Jerry’s among others. Unilever also owns personal care brands such as Dove, Axe, and Dollar Shave club. This would be a very aggressive consolidation in the consumer staples space and the largest Merger since Kraft Heinz two years ago. It would allow Kraft to break into some new product categories since it doesn’t have personal care brands. Kraft has had lagging sales in the U.S. and Europe as customers switch to all natural alternatives that are perceived to be healthier. This will also help Kraft expand geographic footprint as Unilever has the majority of its sales coming from emerging markets. Unilever’s corporate bonds fell after the announcement possibly on the concern that the resulting company will carry a heavy debt burden. Unilever bonds that were issued last week fell 2% in price and now trade below par. An EUR 700mm older issue fell from 102 to 97. Spreads typically tend to widen during an acquisition announcement, and also adding to the concern is that Kraft Heinz’s credit rating is five grades below Unilever’s.

A lot of hedge funds are looking to engage in a trade that is reminiscent practices in the 2008 financial crisis. Investors are using credit default swap indices (CDX) to get exposure to the European corporate bond market. CDS pay out if the underlying company defaults and the buyer pays a premium for that protection. Traders use CDX as an easy and convenient way to take a position on creditworthiness of companies. CDX are tied to premiums of CDS which rise as companies are perceived to be riskier and fall as companies are deemed to be more creditworthy. CDX can be tranched out according to defaults of a certain portion of the index. For example you can sell protection for the index for 5 years but only if a certain percentage of the index defaults. Hedge funds receive small premiums for that, around 40bp depending on the trade and they use leverage to magnify returns. For IG CDX they would be taking the view that no more than 12% of the safest companies in Europe would default. While leverage can magnify their returns it can also lead to losses and instability in the financial system.

Both originators and investors in loans made through online platforms are having trouble. Lenders have had to fire executives and lay off employees for a variety of reasons and investment managers who buy the products that online lenders securitize have struggled with low returns. For example LC Advisors and Colchis Capital Management, two funds that invest in private loans made through peer to peer platforms, both reported low return last year and publicly listed funds are trading at discounts to NAV. Funds have been lagging the Agg (in the absence of a more accurate benchmark) as a result of defaults and delinquencies in loans made on those programs. If money managers decide that the subpar returns aren’t worth the risk then they may ditch the asset class which would be bad for companies such as LendingClub, OnDeck, and SoFi. Those platforms have been trying to keep investors interested by raising credit standards and raising interest rates however credit quality is still poor. Some funds have gotten in trouble and had to restrict investors from pulling out money by buying assets with longer durations than they originally stated. Nevertheless LendingClub said it was seeing a decrease in delinquency rates

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Friday February 17

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