Latest / Bloomberg Intelligence / Moody's Carlson on the Direction of the U.S. Credit Rating

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Moody's Carlson on the Direction of the U.S. Credit Rating · Bloomberg Intelligence

• 0:04
  Speaker 1: Welcome to the Bloomberg pm L podcast. I'm Pim Fox.
• 0:08
  Speaker 1: Along with my co host Lisa Abramowitz. Each day we
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  Speaker 1: bring you the most important, noteworthy, and useful interviews for
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  Speaker 1: you and your money, whether you're at the grocery store
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  Speaker 1: or the trading floor. Find the Bloomberg pm L podcast
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  Speaker 1: on iTunes, SoundCloud and at Bloomberg dot com. In the
• 0:29
  Speaker 1: past month, we have gotten some details about the White
• 0:32
  Speaker 1: House's potential budget, but what will this mean for the
• 0:36
  Speaker 1: US is credit rating. I want to bring in Sarah Carlson.
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  Speaker 1: She's vice president and senior analyst for Moody's Investors Service
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  Speaker 1: in London. And Sarah, you know, we haven't gotten that
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  Speaker 1: many details, and perhaps on purpose, we've found out that, uh,
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  Speaker 1: it will not be released in a more sort of
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  Speaker 1: a fully baked proposal until it is more fully baked
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  Speaker 1: and and it's already pastbuster with some of the members
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  Speaker 1: of Congress. But Sarah, so far do you see anything
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  Speaker 1: that could lead Moodies to downgrade the US from its
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  Speaker 1: triple A rating currently? Well, so far, I mean it's
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  Speaker 1: important to stress that the thing that's going to be
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  Speaker 1: really important for the USS sovereign rating at Moodies is
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  Speaker 1: really what the future path for entitlement spending looks like.
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  Speaker 1: The kind of detail that we've got so far really
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  Speaker 1: doesn't move the dial one way or another there, because
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  Speaker 1: whatever spending cuts, the balance between spending cuts and spending
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  Speaker 1: increases that we're seeing so far don't really create additional
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  Speaker 1: fiscal space for the kind of rise in an entitlement
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  Speaker 1: spending that we're expecting to see over the next five
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  Speaker 1: ten years. Sarah, the number twenty rattles around in my
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  Speaker 1: brain a lot, because I think we're are we at
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  Speaker 1: the twenty trillion dollar mark in terms of federal debt? Uh?
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  Speaker 1: In terms of federal debt, No, they're not. Um So,
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  Speaker 1: I thought that was the US the US Treasury total
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  Speaker 1: public debt outstanding. It could be publicly held debts, So
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  Speaker 1: it's less than that because remember, the US is about
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  Speaker 1: a trillion dollar economy, twenty trillion dollar economy and um,
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  Speaker 1: so that would make the Deutch GDP ratio, which it's
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  Speaker 1: not right because it actually is heading in the wrong direction. Right. So, Sarah,
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  Speaker 1: what are you going to be looking at when we
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  Speaker 1: do get more details about President Trump's budget proposal to
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  Speaker 1: determine whether or not affects the credit worthiness of the
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  Speaker 1: United States. Sure, I mean the big thing, as I said,
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  Speaker 1: that that will really matter is what happens with the
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  Speaker 1: future deficit trends and what that means for future debt trends.
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  Speaker 1: The US does have the highest debt burden of all
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  Speaker 1: of the Triple A rated economies. Now, it has some
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  Speaker 1: other strengths that those other countries don't have, like the
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  Speaker 1: role that the dollar place in the international financial system
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  Speaker 1: by something. But as I say, that's really important to
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  Speaker 1: see what's happening with the debt trajectory. And given the
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  Speaker 1: role that entitlement spending plays in the overall federal budget.
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  Speaker 1: Your mandatory outlays are just under two thirds of total
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  Speaker 1: expenditure by the US, and entitlements are a huge component
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  Speaker 1: of that. That's going to be really important and we'll
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  Speaker 1: be absolutely key for the future rating trajectory. When I
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  Speaker 1: was taking a look at the Congressional Budget Offices UH
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  Speaker 1: forecast for where the deficit would go in the US,
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  Speaker 1: one thing that caught my attention was the increasing provision
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  Speaker 1: set aside for interest payments. How have you modeled for
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  Speaker 1: the rise in benchmark yields in the US, and how
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  Speaker 1: that might play into the credit worthiness of the country. Well,
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  Speaker 1: our expectations for interest expenses are very similar to those
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  Speaker 1: of the Congressional Budget Office. So in fiscal two thousand sixteen,
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  Speaker 1: net interest expenses were around six point four percent. We're
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  Speaker 1: expecting that to go no worth of eleven in fiscal okay,
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  Speaker 1: So based on that, what's the underlying assumption for treasure yields? Uh,
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  Speaker 1: There isn't an unther we it changes from year to year.
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  Speaker 1: Doesn't have to have to have like a sense of
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  Speaker 1: how much it could go up because I mean, for example,
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  Speaker 1: if some of the more dramatic projections for say ten
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  Speaker 1: year yields to go up to five percent in the
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  Speaker 1: next two years, that would shoot up a lot more. No,
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  Speaker 1: of course it would, um. But it also depends, for example,
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  Speaker 1: on the maturity structure of the US that stocks. So
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  Speaker 1: it's not quite so simple as just saying what is
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  Speaker 1: the ten year treasury yield? But are the bottom line
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  Speaker 1: for us is that our expectation is if you look
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  Speaker 1: across the various maturities for US, that that you'll see UH,
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  Speaker 1: net interest expenses as a percentage of total spending almost
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  Speaker 1: double between now and is there a number there that
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  Speaker 1: we can look at. I mean I was thinking, for example,
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  Speaker 1: on the Treasury Direct website, you can get this for
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  Speaker 1: each quarter, and we're talking about a hundred and eighty
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  Speaker 1: eight billion dollars that's just for this fiscal year. UM.
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  Speaker 1: I mean yeah, to give you a sense again of
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  Speaker 1: what's expected for this year, the CBOs baseline assumption is
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  Speaker 1: for seventy billion, rising almost a three hundred billion next year,
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  Speaker 1: and so on and so forth. You're at just over
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  Speaker 1: sixty billion. Sarah, real quick. In two thousand and eleven
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  Speaker 1: SMP downgrade at the U S has Moody's reconsidered whether
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  Speaker 1: they ought to do the same. Uh. The rating and
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  Speaker 1: the out the stable outlook on the US is triple A. Uh,
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  Speaker 1: you know, is what it is. UM. But as I say,
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  Speaker 1: the thing that's really going to be important for US
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  Speaker 1: going forward is what happens with entitlement spending. UM. Because
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  Speaker 1: while there is a great deal of discussion about some
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  Speaker 1: other budget items, uh, those things things like Medicare and
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  Speaker 1: Social Security really dwarf all other expenditures that the US makes,
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  Speaker 1: even dwarf military spending. Thanks very much, Sarah Carlson, Vice President,
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  Speaker 1: Senior analyst at Moody's Investor Service giving us a little
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  Speaker 1: bit of detail on the federal debt and the interest
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  Speaker 1: payments that are going to eat up an even larger
• 6:22
  Speaker 1: portion of the federal budget. Here to help us sort
• 6:38
  Speaker 1: of decipher at least the Keystone XL pipeline is minal
• 6:42
  Speaker 1: vem bu Car. I want to thank you very much
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  Speaker 1: for being here. And UM, I know I messed up
• 6:46
  Speaker 1: your name, but I'm sorry, but you are the Van Burker.
• 6:51
  Speaker 1: I beg your pardon. Who is really our best great
• 6:54
  Speaker 1: energy reporter for Bloomberg. I've reading your stuff all the time.
• 6:57
  Speaker 1: This approval by the by the President for the Keystone
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  Speaker 1: excel is is this a done and dusted situation or
• 7:05
  Speaker 1: are we just going to spend a lot of time
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  Speaker 1: paying lawyers now lots of lawyers. Um, it's not done
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  Speaker 1: in dusted. It was expected that Trump would approve the pipeline. Um,
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  Speaker 1: you know, he already kind of helped Dakota access UH
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  Speaker 1: finish up their project, and we were expecting the federal approval.
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  Speaker 1: But it's far from over. Um. Last time, the company
• 7:24
  Speaker 1: encountered a lot of problems in Nebraska and it's really
• 7:27
  Speaker 1: the state and local level that they're going to be
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  Speaker 1: a lot of you know, protests and litigation going forward.
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  Speaker 1: So this is TransCanada that was granted the permit to
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  Speaker 1: work on the Keystone Pipeline project, correct, And so with
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  Speaker 1: this uh particular project, what will the next step be
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  Speaker 1: for TransCanada to move this closer to a reality? Right?
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  Speaker 1: So they've applied for approval in Nebraska with the state's
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  Speaker 1: Public Service Commission and that's kind of a lengthy process.
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  Speaker 1: There are already opponents who have filed up locations to
• 8:00
  Speaker 1: intervene um and you know, turns into this long process
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  Speaker 1: where the earliest they can actually get approval there is September. UM,
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  Speaker 1: there's lots of public hearings. Uh, you know a lot
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  Speaker 1: of stakeholders that have input, landowners, um, environmental groups. Well,
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  Speaker 1: can you give us a read on how the people
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  Speaker 1: in Nebraska who would be voting on this currently feel.
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  Speaker 1: I mean, what's the sort of tea leaves? Where were
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  Speaker 1: they pointing right now? Well, you know, last time around,
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  Speaker 1: there were a lot of environmental groups that, you know,
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  Speaker 1: just as they have with other pipeline projects, chimed in
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  Speaker 1: about just opposing the use of fossil fuels and developing
• 8:35
  Speaker 1: more infrastructure for fossil fuels. But the other side of
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  Speaker 1: it is the landowners. Um, you know, eminent domain is
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  Speaker 1: actually an issue where these opponents and Republicans agree, uh
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  Speaker 1: a few patches of common ground, and you know, the
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  Speaker 1: land fight is just as much kind of in the
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  Speaker 1: spotlight as the environmental stuff. Does the price of oil
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  Speaker 1: at forty seven dollars a barrel change the dynamics of
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  Speaker 1: this project from when it was first conceived, because as
• 9:02
  Speaker 1: I understand that the oil was supposed to come from
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  Speaker 1: is supposed to come from Canada, from the oil sands
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  Speaker 1: and make its way down to the refining infrastructure that
• 9:11
  Speaker 1: the United States has in order to then ship it,
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  Speaker 1: sell it and make money. Is that something that has
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  Speaker 1: been affected by the strothan oil prices? Right? I mean
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  Speaker 1: that's a question that a lot of people are asking.
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  Speaker 1: When the State Department back issued their environmental review, oil
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  Speaker 1: was around a hundred dollars of barrel. It's about half
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  Speaker 1: that now, you know, hovering around fifty. And people who
• 9:34
  Speaker 1: oppose the project will say that, you know, the dynamics
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  Speaker 1: have changed, it's not economic anymore. Um. The company has
• 9:41
  Speaker 1: you know, said that, no, you still need this because
• 9:44
  Speaker 1: Canadian production is growing um. But the Canadian government is
• 9:47
  Speaker 1: also approving other pipeline expansions too, so it seems like
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  Speaker 1: that bottleneck that you kind of have in Canada right
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  Speaker 1: now is easing. How does this fit into the network
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  Speaker 1: of pipelines that currently exist, because we have the Dakota
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  Speaker 1: Access pie A plan, which was a separate project but
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  Speaker 1: is connected. And I believe that a lot of that
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  Speaker 1: confrontation had to do with Native Americans who were alleging
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  Speaker 1: that the pipeline itself could harm the groundwater and some
• 10:16
  Speaker 1: sacred areas that are upstream from their water supply, right.
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  Speaker 1: I mean the main patch there that got halted was
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  Speaker 1: the pipe that was going to run under like Ohahi
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  Speaker 1: and North Dakota, and that I mean, it's still there's
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  Speaker 1: a case still in court. I mean, the pipeline is
• 10:34
  Speaker 1: basically close to being up and running, um and you know,
• 10:37
  Speaker 1: the courts haven't stopped that, so practically speaking, there's nothing
• 10:42
  Speaker 1: really getting in their way. But that was, Yeah, from
• 10:45
  Speaker 1: the tribal perspective, that was a big thing, um, the
• 10:47
  Speaker 1: issue of water, and that's definitely something that you'll see
• 10:50
  Speaker 1: play out with opposition to Keystone too. When you talk
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  Speaker 1: about imminent domain how much land would have to be
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  Speaker 1: seized from private owners to make way for this project.
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  Speaker 1: You know, that's actually a good question. Um, the route
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  Speaker 1: in Nebraska changed last time around, when you know, this
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  Speaker 1: thing went on for seven years, um, and so we'll
• 11:13
  Speaker 1: we'll see kind of how that plays out after the
• 11:17
  Speaker 1: the process in the PSC in Nebraska plays out. After
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  Speaker 1: getting that approval is when TransCanada would choose to invoke
• 11:25
  Speaker 1: eminent domain and that would launch, you know, a whole
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  Speaker 1: new round of litigation, the effort on the part of
• 11:33
  Speaker 1: President Donald Trump in order to unleash the industrial prowess
• 11:39
  Speaker 1: of the United States. Are there regulations in uh in
• 11:43
  Speaker 1: place right now that you can say that the pipeline
• 11:46
  Speaker 1: owners particularly would like to see a removed I mean,
• 11:50
  Speaker 1: is there a process that that is that is under
• 11:53
  Speaker 1: threat as well? So, and this is something that we've
• 11:57
  Speaker 1: reported on a little bit already. But be sickly, you know,
• 12:00
  Speaker 1: on the federal level, for big projects like this, it
• 12:03
  Speaker 1: makes a difference. You know, you need State Department approval
• 12:06
  Speaker 1: for pipelines across the border. Um, you needed the Army
• 12:10
  Speaker 1: Corps approval for the federal land for Dakota access. But
• 12:14
  Speaker 1: when it comes to this big wave of pipeline opposition.
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  Speaker 1: So much of how these projects get stuck is at
• 12:20
  Speaker 1: the state level, UM, at the local level. And while
• 12:24
  Speaker 1: Trump can green light these big projects, UM, he can
• 12:27
  Speaker 1: make all the promises that he wants to the oil
• 12:29
  Speaker 1: and gas industry, he really can't change the state hurdles.
• 12:33
  Speaker 1: That's not up to him. So there's no magic wand
• 12:35
  Speaker 1: that he can wait and make everything better. Well, do
• 12:38
  Speaker 1: you have a sense of how much economic benefit this
• 12:42
  Speaker 1: project could lend to the US? You know? Well, I mean,
• 12:48
  Speaker 1: because that's that's that's ultimately at the crops of President
• 12:50
  Speaker 1: Trump's whole point, right, which is, let's approve these projects
• 12:53
  Speaker 1: which are going to make which will make America great again,
• 12:55
  Speaker 1: bring back jobs, generate growth. So how much growth is
• 12:58
  Speaker 1: being estimated from from this pipeline project? I mean again
• 13:03
  Speaker 1: the you know what, I'm sorry, I hold that thought
• 13:06
  Speaker 1: for another discussion for right now. We turned to President
• 13:08
  Speaker 1: Donald Trump's meeting with the National Economic Council at the
• 13:10
  Speaker 1: White House. He's expected to address this early announcement recording
• 13:13
  Speaker 1: his approval for the Keystone Exile pipeline. As we were
• 13:15
  Speaker 1: just talking about, let's listen in I okay, you know,
• 13:22
  Speaker 1: it seems like, we're not getting the audio signal right now,
• 13:24
  Speaker 1: but we will throw to it as soon as we
• 13:26
  Speaker 1: get it. Um. But just to continue on that point,
• 13:28
  Speaker 1: I mean, he's talking about the Keystone Excel pipeline inline
• 13:32
  Speaker 1: with the Economic Council. Let's see if we've got some sound. Now,
• 13:35
  Speaker 1: presidential permit for the Keystone Xcel pipeline, Transcanata will finally
• 13:43
  Speaker 1: be allowed to complete this long overdue project with efficiency
• 13:47
  Speaker 1: and with speed. We're working out the final details as
• 13:52
  Speaker 1: we speak. It's going to be an incredible pipeline, greatest
• 13:56
  Speaker 1: technology known demand or a woman. And frankly, uh, we're
• 14:03
  Speaker 1: very proud of it. Russ Curling, President of trans Canada,
• 14:07
  Speaker 1: is right behind me, and I'm gonna have to say
• 14:10
  Speaker 1: a few words. I know, Russ, you've been waiting for
• 14:13
  Speaker 1: a long long time, and I hope you don't pay
• 14:15
  Speaker 1: your consultants anything because they had nothing to do with
• 14:17
  Speaker 1: you anything. In fact, you should ask for the hundreds
• 14:20
  Speaker 1: of millions of dollars backs that you pay them because
• 14:23
  Speaker 1: they didn't do a damn thing. Exfecating with no vote. Right,
• 14:27
  Speaker 1: it's a great day for American jobs and a historic
• 14:30
  Speaker 1: moment for North America and energy independence. This announcement is
• 14:35
  Speaker 1: part of a new year of American energy policy that
• 14:38
  Speaker 1: will lower cost for American families and very significantly reduce
• 14:43
  Speaker 1: our dependence on far and oil and create thousands of
• 14:46
  Speaker 1: jobs right here in America. And I also would like
• 14:48
  Speaker 1: to add, I think it's a lot safer to have
• 14:51
  Speaker 1: pipelines than to use other forms of transportation for your product.
• 14:56
  Speaker 1: When completed, the Keystone Exhale pipeline will span nine hundred
• 15:00
  Speaker 1: miles WOW and have the capacity to deliver more than
• 15:05
  Speaker 1: eight hundred thousand barrels of oil per day to the
• 15:08
  Speaker 1: Gulf Coast refinery at some big pipeline. The fact is
• 15:14
  Speaker 1: that this eight billion dollar investment in American energy was
• 15:18
  Speaker 1: delayed for so long. It demonstrates how our government has
• 15:22
  Speaker 1: too often failed at citizens and companies over the past
• 15:27
  Speaker 1: long period of time. Today we begin to make things
• 15:31
  Speaker 1: right and to do things right. Today we take one
• 15:35
  Speaker 1: more step in putting the job's, wages and economic security
• 15:39
  Speaker 1: of American citizens first, put America first. As the Keystone
• 15:44
  Speaker 1: Excel Pipeline now moves forward. This is just the first
• 15:47
  Speaker 1: of many energy and infrastructure projects that my administration will approve,
• 15:52
  Speaker 1: and we've already approved a couple of other big ones,
• 15:55
  Speaker 1: very very big ones which will be announcing. So in
• 15:58
  Speaker 1: order to help put Americans back to work, grow our
• 16:00
  Speaker 1: economy and rebuild our nation. And with that, I'd like
• 16:06
  Speaker 1: to invite Russ to say a few words. Russ is
• 16:09
  Speaker 1: a very highly respected man in the energy world. He's
• 16:12
  Speaker 1: president of trans Canada. And I know you're gonna do
• 16:17
  Speaker 1: a fantastic job for us and get it up and
• 16:19
  Speaker 1: hire plenty of American people. Thank you, ye, thank you
• 16:23
  Speaker 1: as president, and uh, this is a very very uh
• 16:28
  Speaker 1: important day for us for a company and so on
• 16:30
  Speaker 1: behalf and to build thousands of people that have worked
• 16:33
  Speaker 1: very hard to get here, as you pointed out, a
• 16:34
  Speaker 1: very long time to get here. But we're very relieved
• 16:37
  Speaker 1: and very much just want to get to work. Some
• 16:38
  Speaker 1: of those folks have with me today the building trades
• 16:41
  Speaker 1: with which was Sewan Garvey Um. Some of our our
• 16:45
  Speaker 1: destruction contracts from Quanta are types of flyers from from
• 16:48
  Speaker 1: well spun Um. There's thousands of people that are just
• 16:52
  Speaker 1: ready an itching tip to get to work with a
• 16:54
  Speaker 1: lot of work to do in the field. But as
• 16:56
  Speaker 1: you pointed out, this is the safest and most reliable
• 16:59
  Speaker 1: way to move our ex market. UM, we're gonna use
• 17:01
  Speaker 1: the best technology. UM. It will create thousands of jobs
• 17:05
  Speaker 1: UM and UH tax important tracts revenues in local communities.
• 17:10
  Speaker 1: And that something offense overlooked in new projects like this
• 17:13
  Speaker 1: is local communities benefit greatly from these projects. It gives
• 17:16
  Speaker 1: them tax revenues in which they can invest in schools, hospitals, roads, teachers, nurses,
• 17:22
  Speaker 1: all of those things build the fabric of communities and
• 17:25
  Speaker 1: UH and make the places better for for those posts
• 17:27
  Speaker 1: two ways. So again, thank you very much for this opportunity,
• 17:30
  Speaker 1: and we're not gonna let you down. Sir. Well, thank you,
• 17:32
  Speaker 1: rus And I I know the voters appreciate this. Some
• 17:37
  Speaker 1: of them expressed it very very strongly. The workers definitely
• 17:42
  Speaker 1: appreciated that the building trades heads didn't. But now maybe
• 17:45
  Speaker 1: they're gonna start to where my building places got. I
• 17:48
  Speaker 1: think they're gonna start to because other people were not
• 17:51
  Speaker 1: going to be signing this build that I can tell you.
• 17:54
  Speaker 1: And if it ever did get done, it would be years.
• 17:56
  Speaker 1: But I don't think it would have ever gotten done.
• 17:58
  Speaker 1: So we put a lot of people to work, all
• 18:00
  Speaker 1: great workers to work, and they did appreciate it, and
• 18:03
  Speaker 1: they appreciated Russ very much at the polls, as you
• 18:05
  Speaker 1: probably noticed, and so we're very happy about it. So
• 18:10
  Speaker 1: the bottom line, Keystone finished, They're gonna start construction. When
• 18:14
  Speaker 1: I got to see work to do un Neibraska to
• 18:16
  Speaker 1: get on permits there, looking forward to working through the
• 18:20
  Speaker 1: local Uh. You don't why. Nebraska is a great governor.
• 18:23
  Speaker 1: They have a great governor. We've been working there for
• 18:25
  Speaker 1: some time and I do believe that we'll get through
• 18:28
  Speaker 1: that process. But obviously have to engage with the local
• 18:30
  Speaker 1: landowners tropical communities. So we're reaching out to those over
• 18:34
  Speaker 1: the coming months to get the other necessary permits that
• 18:37
  Speaker 1: we need, and then we look forward to start construction. Okay,
• 18:40
  Speaker 1: I'm sure to addressed it will do good. Pets. A
• 18:41
  Speaker 1: fantastic governor has done a great job. But I'll call
• 18:44
  Speaker 1: him today. So thank you all very much, appreciate it.
• 18:47
  Speaker 1: Thank you. You've been listening to President Donald Trump. He
• 18:52
  Speaker 1: was speaking about his signing of the order approving the
• 18:55
  Speaker 1: construction and completion of the Keystone XL pipeline. In the
• 19:00
  Speaker 1: him With him were Rick Perry. Uh. He is the
• 19:02
  Speaker 1: Secretary of Energy, along with Wilbur Ross, the Secretary of
• 19:07
  Speaker 1: Commerce and also speaking there was Russ Girling. He is
• 19:11
  Speaker 1: the president and the chief executive trans Canada, the construction
• 19:15
  Speaker 1: company that will well the oil pipeline company that will
• 19:18
  Speaker 1: operate the Keystone XL Here to just bring us up
• 19:22
  Speaker 1: to date, we have Menal van Berger. Did I get that?
• 19:27
  Speaker 1: I just have trouble. It's just me. Did you heard
• 19:31
  Speaker 1: that what the president was saying? And then at the
• 19:33
  Speaker 1: very end they talked about Nebraska and that goes to
• 19:36
  Speaker 1: what you were reporting, which is that great you get
• 19:39
  Speaker 1: the federal permits, but it's the local level that is
• 19:42
  Speaker 1: the big issue sometimes, right, Yeah, I mean, you know
• 19:44
  Speaker 1: Trump says, you know, I'll call Nebraska, and they joked
• 19:47
  Speaker 1: about that a little bit, but he can't do that.
• 19:49
  Speaker 1: I mean, and I think, you know, you heard Girling say,
• 19:52
  Speaker 1: we've been doing a lot of work in Nebraska, and
• 19:54
  Speaker 1: you know, we've spent a lot of years trying to
• 19:56
  Speaker 1: figure this out. So I think, uh, you know, they're obviously,
• 19:59
  Speaker 1: like he said, he's relieved, unexcited. But I didn't think
• 20:02
  Speaker 1: they're deluding themselves. They know they have a lot of
• 20:04
  Speaker 1: work to do. Still, thank you so much, Mean Van Berger,
• 20:08
  Speaker 1: energy reporter for Bloomberg, who has so kindly stayed here
• 20:11
  Speaker 1: and reflected on what we have heard, as well as
• 20:13
  Speaker 1: the whole situation and the arduous road ahead to get
• 20:16
  Speaker 1: this pipeline completed regardless of any presidential sign off. You know, Pam,
• 20:34
  Speaker 1: It's really interesting. We hear a lot about activists investors
• 20:37
  Speaker 1: in sort of their influence over companies, but it turns
• 20:42
  Speaker 1: out there actually is a predictable way to identify which
• 20:45
  Speaker 1: companies are vulnerable to such activists intervention. I want to
• 20:49
  Speaker 1: bring in Joel Levington, a senior credit analyst with Bloomberg Intelligence.
• 20:52
  Speaker 1: He is here with us in our Bloomberg eleven three
• 20:54
  Speaker 1: oh studio. Joel, We're so happy to have you first
• 20:57
  Speaker 1: before we talk about how to identify companies that are
• 21:01
  Speaker 1: targets or possible likely probable targets for activists. Why is
• 21:05
  Speaker 1: it important to know whether a company would be uh
• 21:09
  Speaker 1: the target of an activist investor? Sure, Lisa, and thank
• 21:12
  Speaker 1: you for having me Uh. I think there's implications for
• 21:15
  Speaker 1: both the stockholders as well as for bond holders. UH.
• 21:19
  Speaker 1: For stocks, it might be a catalyst for improvement if
• 21:22
  Speaker 1: you can find UH somebody that can lead the company
• 21:26
  Speaker 1: to either improve performance or maybe more optimal balance sheet
• 21:30
  Speaker 1: for credit. Uh, it could work the same way, except
• 21:34
  Speaker 1: tends to be more negative in that uh, activists tend
• 21:38
  Speaker 1: to come in and want to add more leverage into
• 21:41
  Speaker 1: a situation, which is uh, you know, would add credit risk.
• 21:44
  Speaker 1: So in other words, coming from a credit perspective, you're
• 21:46
  Speaker 1: sort of saying, look out, here are some companies that
• 21:49
  Speaker 1: could potentially have surprising shifts in their valuations that could
• 21:54
  Speaker 1: upend some of your expectations. Right, that's right, Okay, that's right.
• 21:58
  Speaker 1: So which companies that you IDEA five? Sure? Well? I
• 22:01
  Speaker 1: didn't identify any of them, Luckily, we Luckily we put
• 22:04
  Speaker 1: a model together that identified a lot of them. Uh.
• 22:06
  Speaker 1: And what we did is we broke it out by
• 22:08
  Speaker 1: different category, the sectors that they're in, and some of
• 22:12
  Speaker 1: the names that screen high or ge which has been
• 22:14
  Speaker 1: flagging in our model going back to two thousand and fourteen,
• 22:18
  Speaker 1: the year before try And actually got involved, as well
• 22:21
  Speaker 1: as Ford and Kroger, they stood out as kind of
• 22:25
  Speaker 1: bigger names for their sectors. What is this measuring? Sure? Well?
• 22:29
  Speaker 1: What what what I did is I went back and
• 22:32
  Speaker 1: looked at a lot of the research papers that try
• 22:34
  Speaker 1: And has produced. And what try And, of course is
• 22:37
  Speaker 1: the vehicle by which Nelson pelts the activist investor has
• 22:41
  Speaker 1: invested previously in PepsiCo UH and currently I believe has
• 22:45
  Speaker 1: a position in a Procter and Gamble, Yes and and
• 22:48
  Speaker 1: G and pent Air in the world of industrials, and
• 22:51
  Speaker 1: so for for them, they looked at a variety of
• 22:54
  Speaker 1: different factors like sales growth, margins, returns, capital intensity of
• 22:59
  Speaker 1: the business and stock performance. And so using the Bloomberg terminal,
• 23:03
  Speaker 1: we put all these factors together and then started measuring
• 23:06
  Speaker 1: peers to see like which stood out. And so out
• 23:09
  Speaker 1: of that comes our flaggers of for companies UH at
• 23:13
  Speaker 1: risk for activism as well as for potential credit reading
• 23:16
  Speaker 1: down grades. When we did this the first time on
• 23:19
  Speaker 1: June sixteenth last year, UH, the eight names that we
• 23:23
  Speaker 1: listed wound up having twelve down grades and no upgrades.
• 23:25
  Speaker 1: So certainly a credit flagg are as well. You know,
• 23:29
  Speaker 1: I want to talk a little bit about the composition
• 23:31
  Speaker 1: of activist investors. When you first hear that words, you
• 23:35
  Speaker 1: think of Carl Icon or some of these other UH
• 23:38
  Speaker 1: sort of big figures. But how much of the activism
• 23:41
  Speaker 1: has shifted to say, mutual fund companies that own a
• 23:45
  Speaker 1: lot of a lot of stocks of a specific company
• 23:48
  Speaker 1: and can consolidate that to be a pretty big voice. Yeah, no,
• 23:52
  Speaker 1: it's a it's a very good point, Lisa, and not
• 23:54
  Speaker 1: only mutual funds, but the type of activists. Whereas a
• 23:57
  Speaker 1: carl Icon might be more aggressive for financial risk changes,
• 24:01
  Speaker 1: there are others such as Starboard or UM or here
• 24:05
  Speaker 1: with Tryan where they focus more on the operational side
• 24:09
  Speaker 1: and how do we improve operations so which is not
• 24:11
  Speaker 1: always a negative for credit if you can, you know,
• 24:14
  Speaker 1: improve the quality of earnings and sales growth. What would
• 24:18
  Speaker 1: be the best use of this information for a bond
• 24:23
  Speaker 1: trade bond investor? And then just tell us also for
• 24:25
  Speaker 1: an equity investor, how would they use it? Sure? I
• 24:28
  Speaker 1: think for a bond investor, the key is, you know,
• 24:31
  Speaker 1: here is a identifiable risk? Are you getting paid for it?
• 24:34
  Speaker 1: That's how I would be looking at it, or at
• 24:36
  Speaker 1: least that's how I was on the on the buy side.
• 24:39
  Speaker 1: If you are an equity person, and maybe that becomes
• 24:41
  Speaker 1: a catalyst of change, and then you can start looking
• 24:43
  Speaker 1: at the holders and where that might be coming from,
• 24:46
  Speaker 1: like who would where's the impetus for it um and
• 24:49
  Speaker 1: what would be the earnings opportunity if the company could
• 24:52
  Speaker 1: achieve either sales growth or margins or whatever the item
• 24:55
  Speaker 1: is akin to its fear set, and that would be
• 24:58
  Speaker 1: the opportunity for you know, like earnings and perhaps appreciation.
• 25:03
  Speaker 1: You know, Joel, I'm interested in the response that you've
• 25:06
  Speaker 1: gotten to this index that you've put together, because for
• 25:10
  Speaker 1: so many years after the crisis, people just repiling into
• 25:12
  Speaker 1: indexes and sort of writing this UH beta wave or
• 25:16
  Speaker 1: you know, just trying to get just something, you know,
• 25:20
  Speaker 1: just basically writing the stimulus. But now it seems like
• 25:22
  Speaker 1: there is so much more focused on picking specific bonds.
• 25:27
  Speaker 1: Have you found that as well, without a doubt, without
• 25:30
  Speaker 1: a doubt, And you know, the customer engagement has been
• 25:32
  Speaker 1: quite good, and in fact it tends to be Can
• 25:34
  Speaker 1: we have more can we get historic data to UH
• 25:37
  Speaker 1: to test prove the system that will be coming out
• 25:40
  Speaker 1: next week? So the baby we'll talk again. Are there
• 25:44
  Speaker 1: any areas that you would like to add to this
• 25:48
  Speaker 1: information pile? Because it's not only what happens, it's the
• 25:52
  Speaker 1: outcome that matters, right, I mean, it's not just well,
• 25:54
  Speaker 1: whether the investor is correct, because in the real world
• 25:57
  Speaker 1: outcome might be quite different. That's exactly right, And that's
• 26:00
  Speaker 1: one of the great things about the tool UH and
• 26:03
  Speaker 1: I guess version two point oh is that because it
• 26:05
  Speaker 1: has historic data in it, we can go back and
• 26:07
  Speaker 1: measure where activists actually hit UH and what was the
• 26:11
  Speaker 1: stock outcome was the bond outcome for most What we
• 26:15
  Speaker 1: find is that the bond outcome was fairly negative and
• 26:18
  Speaker 1: the stock outcome. We have a U S equity strategist
• 26:20
  Speaker 1: that is going to be writing on that in the
• 26:23
  Speaker 1: in the near future. Were there any specific companies that
• 26:26
  Speaker 1: stood out to you other than the ones you've mentioned,
• 26:28
  Speaker 1: because these are big companies General Electric and and so on.
• 26:31
  Speaker 1: I mean, you would have to amass a significant steak,
• 26:34
  Speaker 1: either in bonds or in stock in order to really
• 26:37
  Speaker 1: influence anything. There Are there any smaller companies that popped
• 26:41
  Speaker 1: up on your radar? UH, There's a there's a there's
• 26:45
  Speaker 1: a lot of companies, even like in the supermarket area.
• 26:48
  Speaker 1: I guess the things that that I thought were kind
• 26:49
  Speaker 1: of interesting was that the system UH certainly flagged on
• 26:54
  Speaker 1: more stable companies like a heavily in the supermarket area.
• 26:58
  Speaker 1: On the industrial side, where you have a steady set
• 27:00
  Speaker 1: of cash flow, but maybe a margin issue or you're
• 27:03
  Speaker 1: not growing sales as quick as your peers where something
• 27:07
  Speaker 1: could be done both operationally and also could be done
• 27:10
  Speaker 1: from a balance sheet perspective. You know, I want to
• 27:12
  Speaker 1: switch gears a little bit to another spot in credit
• 27:15
  Speaker 1: markets that's been causing a lot of concern for people,
• 27:18
  Speaker 1: and that is the auto sector. And I know we
• 27:21
  Speaker 1: were talking about this yesterday, Joel. You know, we hear
• 27:23
  Speaker 1: all about the auto loan losses increasing too, liquids is increasing, uh,
• 27:28
  Speaker 1: and and some of the concerns and the poor results
• 27:30
  Speaker 1: that we've seen as a result of that. How is
• 27:33
  Speaker 1: this affecting Hurts and you know Avis and some of
• 27:37
  Speaker 1: these companies that really depend on resale values of cars
• 27:41
  Speaker 1: in order to meet their bogies. Sure, well, I'm a
• 27:43
  Speaker 1: John Mellencamp fin but this does not hurt so good
• 27:46
  Speaker 1: for Hurts. Uh. They have really taken it on the
• 27:50
  Speaker 1: chin since last November where they significantly lowered their earnings
• 27:54
  Speaker 1: guidance because of residual value declines or declines in the
• 27:58
  Speaker 1: values of used ours when they go to sell them,
• 28:01
  Speaker 1: and so they've had to take right offs on that.
• 28:04
  Speaker 1: Ford was out yesterday commenting that you know that they're
• 28:07
  Speaker 1: seeing declines and values. Also this week, Ali Financial came
• 28:11
  Speaker 1: out with commentary basically saying that that they're seeing significant
• 28:15
  Speaker 1: weakness there too, more than what they expected, which is
• 28:18
  Speaker 1: really crushed Hurts bonds, Avis's bonds, and to a lesser effect,
• 28:23
  Speaker 1: some of the o e ms that are auto manufacturers
• 28:26
  Speaker 1: that have captive finance companies where that derivative exposure is
• 28:30
  Speaker 1: going to be as well. Last point to here when
• 28:32
  Speaker 1: you mentioned Ally Financial, which of course is the old GM,
• 28:36
  Speaker 1: which is the financing arm. One of the comments that
• 28:39
  Speaker 1: we got this week about their uh, their position was
• 28:42
  Speaker 1: that the subprime borrower in automobile loans is who is
• 28:47
  Speaker 1: in trouble. The If you've got good credit, you're paying
• 28:52
  Speaker 1: your bills. It's the subprime area where we're seeing more
• 28:55
  Speaker 1: delinquencies and defaults. Yeah, pay me your spot on and
• 28:58
  Speaker 1: uh my, my colleague Ryan O'Connell has done some great
• 29:01
  Speaker 1: work on this where he shows like if you look
• 29:03
  Speaker 1: at the last three quarters both for Ali Financial and
• 29:06
  Speaker 1: Capital One, their net charge offs have been increasing each quarter.
• 29:11
  Speaker 1: So it's telling you that there's a component of the
• 29:13
  Speaker 1: economy that isn't doing as well as you know, like
• 29:16
  Speaker 1: what might be dictated by by the stock market over
• 29:19
  Speaker 1: the last several months that makes sense. Well, thanks very
• 29:22
  Speaker 1: much to Levington. He is a Levington. He is a
• 29:25
  Speaker 1: senior credit analysts for Bloomberg Intelligence. I always learned something
• 29:28
  Speaker 1: new when we when we have you one because you
• 29:31
  Speaker 1: focus on something specific and then give us that broad
• 29:34
  Speaker 1: reason for understanding it. Investing in airlines, let's find out
• 29:50
  Speaker 1: from Frank Holmes. He is the chief executive and the
• 29:52
  Speaker 1: chief investment officer of US Global Investors. They are based
• 29:56
  Speaker 1: in San Antonio, Texas. Frank joins us in the studio
• 29:59
  Speaker 1: here at Boomberg World Headquarters. Frank, always a pleasure, thanks
• 30:02
  Speaker 1: for being here. Um airlines, you know warm we keep
• 30:06
  Speaker 1: Whenever you hear airlines, I think warm. Buffett. Yes, he
• 30:08
  Speaker 1: said he would never invest in them. Now he will
• 30:11
  Speaker 1: UM tell us about the whole airline industry as in
• 30:15
  Speaker 1: terms of investments, because I would wonder whether there is
• 30:18
  Speaker 1: any uh, you know, pressure because of potential travel bands
• 30:23
  Speaker 1: and changes in the in the legal restrictions about what
• 30:26
  Speaker 1: goes on in the airlines. I think that there's no
• 30:29
  Speaker 1: doubt there that impact is some of the global travel.
• 30:32
  Speaker 1: But what's really happened. I think that's a change for
• 30:35
  Speaker 1: why Buffett and when we first talked about this. In
• 30:37
  Speaker 1: launching the jet C t F, the question was he
• 30:40
  Speaker 1: was a head wind buffett towards the airlines because he
• 30:43
  Speaker 1: was anti Now he's a tail wind UH and he
• 30:47
  Speaker 1: and went into the industry. I think for three reasons.
• 30:50
  Speaker 1: One is it's a motor around the industry. It's very
• 30:52
  Speaker 1: hard to build a new airport or get new UH
• 30:55
  Speaker 1: slips to be able to fly back and forth. There's
• 30:58
  Speaker 1: a shortage of pilots. The rules becoming a pilot changed dramatically.
• 31:02
  Speaker 1: The CEO is like the CEO of American airlines, take
• 31:05
  Speaker 1: stock in lieu of salary, so they're much more focused
• 31:08
  Speaker 1: on returns on capital bottom line. They have the highest
• 31:11
  Speaker 1: castle returns and capital in their history, and they're very
• 31:13
  Speaker 1: disciplined for it. So I think that that's more significant
• 31:17
  Speaker 1: of why he spent ten billion dollars buying the four
• 31:20
  Speaker 1: big pillars of the airline industry. Frank, I'm looking at
• 31:23
  Speaker 1: your jets e t F which invests in airline shares,
• 31:26
  Speaker 1: and the expense ratio is point six percent, which is
• 31:29
  Speaker 1: actually quite a bit higher than a lot of other
• 31:32
  Speaker 1: e t f s and equity funds. What do you
• 31:36
  Speaker 1: do to provide value and earn that point six percent
• 31:39
  Speaker 1: in this fund. It's a great question. It's a smart beta,
• 31:42
  Speaker 1: and then they call it a smart beta too, not
• 31:44
  Speaker 1: only because of how we screen stocks that go into it.
• 31:48
  Speaker 1: It is the overall structure that the four major airlines,
• 31:52
  Speaker 1: which represent of all air travel in America, are forty
• 31:56
  Speaker 1: five percent of the of the fund, and they rebalance
• 32:01
  Speaker 1: each quarter. And then we look at those companies that
• 32:04
  Speaker 1: have the highest cash forward turns on invested capital the
• 32:08
  Speaker 1: what they call the revenue perceived mile, and we screen them.
• 32:11
  Speaker 1: So there's about a change each quarter of screening old
• 32:16
  Speaker 1: stocks that don't qualify for this detailed financial analysis. And
• 32:21
  Speaker 1: we did both four thousand hours of research doing back
• 32:24
  Speaker 1: studies of looking during the when they were through bankruptcy,
• 32:28
  Speaker 1: what were the best factors to deal with in a
• 32:30
  Speaker 1: rising market of following market price of oil rising price
• 32:33
  Speaker 1: of oil falling, And we came up with five factors.
• 32:36
  Speaker 1: And I really thrilled about it because it's doing exactly
• 32:39
  Speaker 1: what our performers showed it would do. And our US
• 32:45
  Speaker 1: companies are foreign. But what's interesting is that se of
• 32:50
  Speaker 1: the names are foreign, so they're only kept it one percent,
• 32:53
  Speaker 1: so they really don't currency swings don't impair it, but
• 32:56
  Speaker 1: it does capture if an airline's is very strong out
• 32:59
  Speaker 1: of Asia. Uh. And the other interesting part is that
• 33:01
  Speaker 1: they can buy airports, and airports here are not owned
• 33:05
  Speaker 1: by the public, but they're very big private equity. Beijing
• 33:09
  Speaker 1: is a public, Bangkok is public. Uh and also in Mexico. Wa. Wait,
• 33:14
  Speaker 1: hold on a second, how does an e t f
• 33:17
  Speaker 1: by airports or a state in airports that are as
• 33:22
  Speaker 1: you say, largely financed through private equity in debt, Well,
• 33:25
  Speaker 1: they're like there, it's more of a private equity model,
• 33:29
  Speaker 1: so that the Toronto stock than the Toronto Airport. The
• 33:32
  Speaker 1: Pearson is a private equo owned by private equity. The
• 33:35
  Speaker 1: interesting part is that you can buy airports outside of
• 33:39
  Speaker 1: the US that are public and they grow their cash
• 33:42
  Speaker 1: low at a fift caagar uh. So that means every
• 33:46
  Speaker 1: five years at doubles. That's very much how private equity functions.
• 33:50
  Speaker 1: So I think that they qualify and they will show
• 33:53
  Speaker 1: up as soon as they're cash flow and their revenue
• 33:55
  Speaker 1: per share on a quarterly basis is lagging over four quarters,
• 33:59
  Speaker 1: they're out. This is why you got what the Macquarie
• 34:02
  Speaker 1: Infrastructure Fund is part of your holding. Yes, and they
• 34:06
  Speaker 1: own uh and they have a couple of them, but
• 34:08
  Speaker 1: the one we own a particular owns airports. Right. Um,
• 34:11
  Speaker 1: I want to just focus on American airlines because you
• 34:13
  Speaker 1: brought that up for a second. I mean, this is
• 34:15
  Speaker 1: a stock that was trading your fifty dollars to share
• 34:17
  Speaker 1: in January. Also in December, it's down, you know, it's
• 34:21
  Speaker 1: down almost from those highs. But this is stock that's
• 34:25
  Speaker 1: pretty volatile. Airlines are volatile investments, right, I mean this
• 34:27
  Speaker 1: was a twenty five dollar stock back in last summer.
• 34:30
  Speaker 1: So you've got to be aware of that, don't you. Absolutely,
• 34:33
  Speaker 1: And the data on on the airline's industry is much
• 34:38
  Speaker 1: greater than the overall market and it reminds me of biotechnology.
• 34:41
  Speaker 1: And it's also like gold stocks. I was gonna say,
• 34:44
  Speaker 1: do you balance this out with your goal position, because
• 34:46
  Speaker 1: I know that you you're gonna talk about gold, But
• 34:48
  Speaker 1: I mean, if you want, if you want volatility, go ahead,
• 34:50
  Speaker 1: get an airline. But will the gold at around an ounce?
• 34:54
  Speaker 1: Would that in mitigate any of the volunt that has
• 34:58
  Speaker 1: a different set of animals to drive the the gold space.
• 35:01
  Speaker 1: So energy is what happens in oil prices. Oil was
• 35:04
  Speaker 1: rising until a couple of weeks ago and then it
• 35:06
  Speaker 1: started petering out and falling below fifty dollars, So it's
• 35:10
  Speaker 1: psychologically has an impact on the evaluations. Oil won't have
• 35:14
  Speaker 1: a real significant impact on their cash loollness it's over
• 35:16
  Speaker 1: sixty dollars in barrel for a period of time, I
• 35:20
  Speaker 1: don't see that. I think it vacillates in between forty
• 35:22
  Speaker 1: and sixty dollars price of oil. So these companies are
• 35:26
  Speaker 1: throwing off lots of cash flow. American is just one
• 35:30
  Speaker 1: of those those animals, and you're right, they are just
• 35:33
  Speaker 1: more volatile. But the basket itself, when you own the
• 35:36
  Speaker 1: e t F lowers that volatility. And that's what's really
• 35:40
  Speaker 1: important for investors that you are capturing the trend in
• 35:44
  Speaker 1: the industry. And it's really important to follow middle class.
• 35:47
  Speaker 1: A rise in the middle class is very important for travel.
• 35:50
  Speaker 1: Uh two million people a day flying America. The biggest
• 35:54
  Speaker 1: tourists in the in the world have been Americans because
• 35:56
  Speaker 1: of the strong middle class of almost a hundred million people.
• 35:59
  Speaker 1: Now China is an equal of size in middle class,
• 36:03
  Speaker 1: and so you're seeing the Chinese or they just had
• 36:05
  Speaker 1: the report of American Airlines. What wanted to take a
• 36:08
  Speaker 1: potential taken in China Southern Airways, correct, and that's all
• 36:13
  Speaker 1: trying to cater to this cross the Pacific travel opportunity.
• 36:18
  Speaker 1: And so I think that we have some unique opportunities
• 36:22
  Speaker 1: here in this industry because they're much most important for
• 36:26
  Speaker 1: us as investors. They're much more disciplined on driving high
• 36:29
  Speaker 1: returns investor capital. Which region in the world do you
• 36:32
  Speaker 1: think is the best potential place for airlines right now?
• 36:38
  Speaker 1: I would think Asia. Uh. You saw how fast last
• 36:41
  Speaker 1: year Delta and United cut back a lot of flights
• 36:45
  Speaker 1: to Europe as a europe euro was falling and trade
• 36:48
  Speaker 1: coming over here Europeans slowing down. Um. But Asia, the
• 36:52
  Speaker 1: Hong Kong dollars pegged to the dollar. Uh, it's much
• 36:56
  Speaker 1: more stable. And they all want to come to America.
• 36:59
  Speaker 1: They love America, right, Franklin, thank you so much for
• 37:03
  Speaker 1: joining US. I really appreciate it. CEO and Chief Investment
• 37:06
  Speaker 1: Officer of US Global Investors based in San Antonio, Texas,
• 37:10
  Speaker 1: which is a beautiful, beautiful city. Thanks for listening to
• 37:17
  Speaker 1: the Bloomberg P and L podcast. You can subscribe and
• 37:20
  Speaker 1: listen to interviews at iTunes, SoundCloud, or whatever podcast platform
• 37:26
  Speaker 1: you prefer. I'm pim Fox. I'm out there on Twitter
• 37:28
  Speaker 1: at pim Fox. I'm out there on Twitter at Lisa Abramo.
• 37:32
  Speaker 1: It's one before the podcast. You can always catch us
• 37:35
  Speaker 1: worldwide on Bloomberg Radio