Coinbase Debt Was “Canary in the Coal Mine” for Crypto Meltdown

(Bloomberg) — In the wake of the spectacular collapse of Sam Bankman-Fried’s crypto empire, many investors are looking for warning signs that may have heralded the contagion that was about to unleash. One chance? Coinbase Global Inc Junk Bonds

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The largest US digital asset trading platform has seen the price of its bonds tumble this year. In early January, the price of one of its most active banknotes was around 92 cents. It then fell to around 77 cents in April before falling to 63 cents during the Terra Luna market crash in May. The bonds traded about 53 cents on the dollar — a level typically associated with distress — in Wednesday morning trading in New York, according to trading data from Trace.

The decline is largely attributed to the so-called cryptocurrency winter which has leveled the digital currency markets this year. But for some in the industry, the plunge was a harbinger of the carnage that was soon to be unleashed.

The cryptocurrency exchange’s debt can be described as a “canary in the coal mine,” Bloomberg Intelligence credit analyst David Havens said in a telephone interview. Notably, “something that really caught the eye” in May was Coinbase’s observation that customers could be treated as general unsecured creditors if the company went bankrupt.

This took many people by surprise and raised several questions, according to Havens: “Failure? What were they seeing, hearing, feeling that compelled the lawyers to include that statement at the time,” he said. And secondly, “Clients. regular?

At the time, Brian Armstrong, chief executive of Coinbase, said the company added risk disclosure due to a new accounting requirement from the US Securities and Exchange Commission.

It contributed to the decline in bonds and proved to be one of the indicators of what was to come.

Coinbase’s bond yield is currently roughly between 13 and 15%. “We believe this fully reflects cryptocurrency uncertainty and technical downsides, with few buyers willing to step in with what remains of 2022,” Havens wrote in a note on Monday.

“The bonds reflect the animal spirits that are happening right now,” she said in the phone interview. “And this is the fear that has engulfed cryptocurrencies.”

Any recovery in debt, however, could be an early sign that the market is starting to thaw, according to Havens. “But it’s been a painful ride so far,” he said. “We are at a turning point.”

Debt collection near?

There may be a path to positive returns for Coinbase bonds, according to Havens. He points out that the cryptocurrency exchange has $5.4 billion in liquid assets and is actively engaged with regulators, differentiating it from other exchanges such as Bankman-Fried’s FTX and Changpeng “CZ” Zhao’s Binance.

“Coinbase should buy back as many bonds as possible at the moment to demonstrate its commitment to a reasonable balance sheet,” added John McClain, high-yield portfolio manager at Brandywine Global Investment Management. “Leverage has destroyed many of their competitors and they have a unique opportunity to deleverage in a very attractive way.”

Longtime high-yield bond analyst Marty Fridson also shares a more positive outlook on downed bonds. Fridson, who is chief investment officer at Lehmann Livian Fridson Advisors LLC, believes BB-rated notes trading at distressed levels, including Coinbase, may be better described by their rating level than their current price, according to a Nov. 19 survey. . 15 Pitch Book Analysis.

Note that Coinbase’s debt trades at distressed levels while maintaining one of the highest speculative grade ratings. Moody’s Investors Service reports just a 0.79% annual default rate for Ba issuers for the period from 1970 to 2021, its analysis showed.

“In contrast, I estimate the one-year average default rate on distressed issuers over the period 1997 to 2021 at 38%, suggesting a huge mismatch between a BB rating and a distressed rating,” he wrote.

The yield on Coinbase bonds is currently well above the average yield of 7.1% at which similarly rated debt is trading. This too suggests a mismatch between the price the market is setting for debt and how sound of a bet credit assessors think it is.

To be sure, the market is still fragile. The fallout from the FTX meltdown has already sparked a wave of bankruptcies and it’s probably too early to tell which players will still be around when the dust settles.

Underwriting anything cryptocurrency-related is difficult, except perhaps crypto companies with major assets like mining rigs or other infrastructure, said Hunter Hayes, portfolio manager of the Intrepid Income Fund at Intrepid Capital Management.

“There is no intrinsic value,” he explained. “It’s like Tinkerbell: if people don’t believe in cryptocurrencies, it disappears.”

Buy the dip

Bullish equity managers are already diving in to buy the dip. Cathie Wood’s Ark Investment Management funds have bought more than 1.3 million shares of Coinbase since early November, when FTX began to crash. Meanwhile, debt has climbed from an all-time low set earlier this month.

Since the beginning of the year, shares are down more than 80%, while Bitcoin is down about 65%. As of Tuesday’s close, shares are estimated to need a staggering 782% rally if they are to hit their 12-month average price target from the start of 2022.

Elsewhere in the credit markets:

Americas

General Electric Company announced that approximately $9.3 billion of dollar-denominated bonds were validly tendered and not called on or before the Early Participation Date as part of its recent repurchase offer.

  • Rite Aid said about 33% of eligible notes were offered within an early maturity after it offered to buy up to $200 million of its 7.5% senior secured notes due in 2025

  • T. Rowe Price Group Inc., the $1.3 trillion global financial manager, is cautious on US corporate debt given its exposure to overly aggressive Federal Reserve policy

  • The three-month London interbank rate for the dollar rose to its highest level since the financial crisis on an otherwise quiet day for the front-end of fixed income markets

  • For offer updates, click here for the New Issue Monitor

  • For more information, click here for Credit Daybook Americas

EMEA

Borrowers flocking to the European debt market are selling bonds with the lowest average maturity in four years. Bonds sold this month by investment-grade issuers in the common currency have an average maturity of approximately 6.3 years, the lowest since December 2018.

  • Issuers on Wednesday included Severn Trent in the pound market, while Continental AG, GSK Capital and Liberty Mutual Group offered euro-denominated deals

  • Foreign companies seeking funds from a niche German debt market could face a lukewarm reception from potential lenders hit by the scandal of French nursing home operator Orpea SA

  • Indices tracking the cost of European corporate insolvency insurance were on track for their lowest close since June

Asia

Yield premiums on investment-grade bonds in Asia outside Japan rose for the third straight day on Tuesday, according to data compiled by Bloomberg.

  • Chinese developers are issuing more bonds under a government guarantee scheme, suggesting that increased government support to ease the industry’s liquidity woes is paying off

  • China’s green bond market has grown to over $300 billion, and an analysis by Bloomberg reveals major gaps in disclosure and transparency, as it’s nearly impossible to know how the money is being spent and whether it’s having the expected impact

–With the assistance of Yueqi Yang.

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