Coinbase Debt Was a ‘Canary in the Coal Mine’ for Crypto Meltdown

(Bloomberg) — Following the dramatic collapse of Sam Bankman-Fried’s crypto empire, many investors are looking for warning signs that may have predicted the contagion that was about to unfold. A possibility ? Coinbase Global Inc.’s junk bonds

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The largest U.S. digital asset trading platform has seen its bond prices plummet this year. At the beginning of January, the price of one of its most active tickets was around 92 cents. It then slipped to around 77 cents in April before dropping to 63 cents amid the Terra Luna stock market crash in May. Bonds were trading at about 53 cents on the dollar — a level typically associated with distress — early morning in New York on Wednesday, according to bond trading data from Trace.

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

The crypto exchange’s debt can be described as a “canary in the coal mine,” Bloomberg Intelligence credit analyst David Havens said in a phone interview. In particular, “something that really caught the eye” in May was the fact that Coinbase noted that customers could be treated as general unsecured creditors if the company goes bankrupt.

This surprised many people and raised several questions, according to Havens: “Bankruptcy? What did they see, hear, feel that compelled the attorneys to include that statement at that time,” he said. And second: “Customers. Wait what? Perhaps we are pari passu with the bondholders, and not separated as we would be in a regular exchange? »

At the time, Coinbase chief executive Brian Armstrong said the company added risk disclosure due to a new accounting requirement from the U.S. 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 between 13-15%. “We believe this fully reflects the current crypto uncertainty and negative technicals, with few buyers ready to step in with what remains of 2022,” Havens wrote in a note on Monday.

“The links reflect the animal spirits that are unfolding right now,” he said in the phone interview. “And it was fear that engulfed crypto.”

However, any recovery in debt could be an early signal that the market is starting to unfreeze, according to Havens. “But so far the journey has been painful,” he said. “We’re kind of at a tipping point.”

Debt collection soon?

According to Havens, there could be a path to positive returns for Coinbase bonds. He points out that the crypto exchange has $5.4 billion in liquidity and is actively engaged with regulators, which sets it apart from other exchanges like Bankman-Fried’s FTX and Changpeng “CZ” Zhao’s Binance.

“Coinbase should redeem all possible bonds at this time 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 reduce leverage in a very attractive way.”

Marty Fridson, a longtime high-yield bond analyst, also shares a more positive view on battered bonds. Fridson, who is chief investment officer at Lehmann Livian Fridson Advisors LLC, believes that BB-rated notes trading at distressed levels, including Coinbase, may be better described by their rating level than their current price, according to a PitchBook analysis. of November 15.

He notes that Coinbase’s debt is trading at distressed levels while holding one of the highest speculative grade ratings. Moody’s Investors Service reports a one-year default rate of just 0.79% for Ba issuers for the period from 1970 to 2021, according to its analysis.

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

Coinbase’s bond yield is currently well above the 7.1% average yield at which debt with similar ratings trades. It also suggests a dislocation between the price the market is setting for debt and the strength of the bet that credit assessors think it is.

Admittedly, the market is still fragile. The fallout from FTX’s collapse 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 crypto-related is difficult — except perhaps crypto businesses with hard 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 the usefulness of crypto, it disappears.”

Buy the dip

Bullish equity managers are already diving to buy the dip. Cathie Wood’s Ark Investment Management funds have purchased more than 1.3 million Coinbase shares since early November, as FTX began to tumble. Meanwhile, debt has recovered from its record high set earlier this month.

Year-to-date, stocks are down more than 80%, while Bitcoin is down around 65%. As of Tuesday’s close, stocks were estimated to need a staggering 782% rally to reach their 12-month average price target from the start of 2022.

Elsewhere in the credit markets:

Americas

General Electric Co. announced that approximately $9.3 billion of dollar-denominated bonds had been validly tendered and not withdrawn by the early participation date under its recent tender offer.

  • Rite Aid said around 33% of eligible notes were handed over at short notice after offering to buy up to $200 million of its 7.5% senior secured notes due 2025

  • T. Rowe Price Group Inc., the $1.3 trillion global fund manager, is cautious about US corporate debt given its exposure to the Federal Reserve’s overly hawkish policy

  • The three-month London interbank offered rate for the dollar hit its highest level since the financial crisis on an otherwise calm day for the front end of bond markets

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

  • To learn more, click here for Credit Daybook Americas

EMEA

Borrowers crowding into the European debt market are selling bonds with the lowest average maturity in four years. Bonds sold this month by high-quality issuers in the common currency have an average duration of around 6.3 years, the lowest since December 2018.

  • Among Wednesday’s issuers were Severn Trent in the sterling market, while Continental AG, GSK Capital and Liberty Mutual Group offered euro-denominated offerings.

  • Foreign firms seeking funds in a niche German debt market could face a lukewarm reception from potential lenders stung by the scandal at French care home operator Orpea SA

  • Indices that track the cost of European corporate default insurance were on track to close at their lowest since June

Asia

Yield premia on investment-grade bonds in Asia excluding Japan widened for a third straight day on Tuesday, according to data compiled by Bloomberg.

  • Chinese promoters are issuing more bonds under a state guarantee program, suggesting that increased government support to ease the sector’s liquidity problems is bearing fruit

  • China’s green bond market has surpassed $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 has any impact. expected impact.

–With the help of Yueqi Yang.

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