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IG GE Perp and Citi Trups

Investment Grade GE 4% Perp and Citi Trups at 11.2% YTC, 5.1% RY: Update

IAM Credit View

The likelihood of a call has increased to 75%. Why?

  • GE is in the midst of a portfolio shake-up and will be forming three public companies.
  • By 2024, the Company will have spun off its healthcare and power and renewables businesses, leaving the aviation unit along with various legacy liabilities as the remaining entity for investors to monitor. Full balance sheet details post spins are not yet made available.
  • GE needs to continue purchasing certain debt instruments to reduce its leverage to be in line with previous company goals.
  • The need for additional debt paydown beyond the expected Q4 2021 LME tender is now a little more apparent than it previously had been.

Likelihood of call: General Electric USD Legacy Hybrids: 75%

GE has not issued a subordinated note (preferred stock) since 2015 and continues to enjoy relatively cheap and abundant senior debt funding across the curve. The likelihood of a call will largely be driven by how GE would like to manage its Baa1/BBB/BBB+ credit ratings and whether they’d like to clean up their capital stack.

  • As of FY 2020, GE has a huge amount of cash as well as deferred revenue that sitting on its balance sheet.
  • Moody’s and Fitch don’t consider GE’s large cash balances/deferred revenue in their credit metrics − that is they look at gross not net debt. S&P views this differently with their credit metrics focused on net debt, but they are also BBB+ (at the higher end of the 3 rating agencies − see calculations in the BBG table below).
  • GE has a long-term goal to ultimately get back to a single-A credit rating. Thus, the company might have to decide between executing on debt tenders that may not be economically attractive or potentially face pressure from Moody’s and Fitch to improve their ratings.
  • The likelihood of a call may be driven by administrative clean-up rather than the commercial cost of replacing the capital instrument. The USD91m issue size is an annoyance given the size of the balance sheet.

In our view, we would place the probability of a call at 75%. Even if a call were to not take place at the first available date for the notes, the ongoing income on these securities is relatively good for what would be considered a low IG rated note.

The following text is from an August 2021 IAM Trade Idea.

We view the USD GE 4% Perp and the USD Citigroup Capital XIII preferred as two opportunities to generate a high income return from investment grade rated assets. Both are legacy capital instruments, meaning their structures do not follow the Basil III Tier 1 framework we see from new issues today.

Both deals offer value, but the premise for entering the trades differ between the two issues. For GE, a call at next opportunity in June-2022 is beneficial and will deliver significant upside to investor returns, given it is trading well below its redemption value of AUD100. Conversely, a call on the Citigroup Capital XIII issue will be detrimental to returns given it is trading above its redemption value of AUD25.

Likelihood of call: Citigroup Capital XIII: Recent results make a call unlikely in the near term

  • Citigroup has simplified its business structure and operations due to regulatory pressures, which bodes well for credit investors.
  • On the Q2 2021 investor call, Citi’s CEO (Jane Fraser) spoke about the company’s capital stack and a higher G-SIB score, which will require additional capital. The implementation of higher capital in relation to G-SIB (3.5%) will come into effect in 2023.
  • The company monitors the 11.5% capital target, which is currently above regulatory minimums.
  • There are elements the company can control − including the stress capital buffer and balance sheet risk − and elements the company cannot.

The read-through for the CitiGroup Capital XIII (Trups) is simple: these will remain a stagnated part of the company’s capital stack. Not only will it be a costly adventure to call the capital, but it also won’t be economically viable. The company has many options available to modify their balance sheet risk and stress capital buffer outside of calling this particular capital. The longer the Citi security remains in the market, the better the return outcome.

Trade Idea: 50/50 Exposure

In our view, coupling the two issues together delivers a high IG income return, positions the investment to benefit from capital upside if the GE is called, whilst also bolstering running yield if it isn’t.

Issue ISIN Clean Price YTC Running Yield Call Date Coupon If not called Moody’s, Fitch, S&P Amount Issued Amount Outstanding
GE 4% Perp (Series A) US369604BM44 AUD93.50 16.8% 4.3% 15/06/2022 4.00% 3m LIBOR +2.28% Baa3, BB+, BBB- AUD2.78bn AUD91m
Citi Trups US1730802014 AUD27.70 5.6% 5.9% 30/10/2040 3m LIBOR + 6.37% 3m LIBOR+6.37% Baa3, BB+, BBB- AUD898m AUD898m
11.2% 5.1% 4.5%*

(*) Calculation based on current 3m LIBOR

Best case scenario: GE 4% Perp called in June-2022, Citigroup Capital XIII (Trups) not called for an extended period of time.

Worst case scenario: GE 4% Perp not called coupled with a sooner than anticipated repayment of the Citigroup Capital XIII (Trups). We view this as very unlikely.

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