Hello, and welcome to The Credit Edge, a weekly markets podcast. My name is James Crumbie. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome to the show Scott Carpenter, who covers structured finance for Bloomberg News in New York. How are you doing, Scott, doing very well? Thanks for having me. We're also delighted to see Louise Parker, who covers consumer companies for Bloomberg Intelligence based in London. Hello Louise, Hi.
James, thanks for having a long story.
We'll be coming back to Louise later in the show to talk about two of my favorite things, beer and the US culture wars. So do stay with us. But first, Scott Carpenter with Bloomberg News office buildings. Why are they under such pressure now? Why is everything blowing up?
Well? The short answer is from home. Now. You might remember back in February everything kind of this story exploded onto the scene when Brookfield defaulted on to La office towers. Brookfield is a very big company. It's not as though that company is facing serious distress. What it was doing was realizing whoa A lot of people are working from home?
Now?
These buildings aren't worth as much as they used to be their office buildings, so they chose to default, which meant that they're effectively not choosing to refinance. And then not too much long after that, another big company, Pimco, also defaulted on some office towers and for similar reasons. You've been seeing more and more of this over time, and it's become almost a staple of headlines. You see, this office building is falling behind, or this one is defaulted,
and so on. And one thing that happened recently is that these defaults are piling up and they're starting to rise at a faster radar, not only defaults, but also the rate at which office loans are falling behind on their payments.
So sorry, let me just tell you that. So, people aren't going back to the office because of you know, obviously we're working from home for much of the pandemic. But now people are going back to the office. Everyone's coming into work, the subway's a pact. What's going on and why I think coming to a head right now?
Two reasons. First, even though people are going back to the office, there's a new regime of the three day work week. This has changed everything it means that yes, you're going back to the office, but you're not going as much. And companies know this and they're looking to downsize into smaller offices. So they're they're looking to shift from one building to a smaller building, maybe a more modern, nicer building as well. It's a good opportunity. The other thing is higher interest rates.
So people use those desks and they share them, so they go in. People come in different days. I mean, it seems like there's big peaks and troughs in that whole return to work thing. Everyone's coming in on Tuesdays to Thursday and off one Monday to Friday. Don't you still need the same kind of office to do that.
Yeah, you do. There's always going to be office. The offices are always going to be around. I think people, I think companies are looking at this thinking this is this is our moment to switch to a nicer office. They're they're changing things up and they're just they're just realizing that far fewer people are coming into the office. I think that I think the standard work week is now three days a week in the office, two at home or the or the or the similar two days
a week in the office three days at home. Overall, that result in all lot less demand for offices office space.
So let's talk about the other point. You raise higher interest rates. Obviously rates have shot up much faster and much more than most people expected. Why does that become such a problem for office buildings.
Well, if you're an office landlord and you need to rent out some space at a nice, fancy building, you used to be able to do that at pretty low rates, but then the Fed raised rates. Now either you want to maybe you need to refinance your existing loan. Suddenly it's a lot higher, you know, several percentage points higher, which can really start to add up. So you combine that with the fact that you don't need that office quite as much as you used to, and suddenly you're
looking at alternatives. You want a smaller office, you want to move to somewhere else. It just overall makes it much less, much more expensive and therefore lesser active.
So you've written, you mentioned to philps, but you've written a lot about delinquencies. What does that mean? Why delinquent office loans out a five year high.
A delinquency is a word that means you've fallen behind on your payments, usually an interest payment and delinquency rates on office loans right a five year high, so they're about there are four percent, and this is according to Trepp, which keeps which attracts a lot of data on offices and commercial real estate property. Four percent doesn't sound like a whole lot, but it's the highest since twenty eighteen.
And remember back in twenty eighteen, there were still a lot of office loans out there from the pre two thousand and eight era when it were very easy loan terms, and probably some office company borrowers were getting loans that they shouldn't have been. So now now it's different. Now what we're seeing is related to the pandemic, and it's
by all accounts, it's going higher. This is probably going to be just the beginning of the sharp uptick in the rate at which these office loans are falling behind. There was a there was another there was a podcast co host of Trapp who said it could get to ten percent by the end of this year. So ten percent of all office loans at least tied to a certain part of the finance sector CMBs that will fall behind at least thirty days behind on one of their payments.
So you mentioned CMBs, which immediately sets off jogging alarms in my head. Explain what that is? I mean, you know, anytime there's an acronym in finance often ends in TIS. What's the CMBs.
CNBS stands for commercial mortgage backed securities, And you can think of it as a pool. It's a pool of commercial loans, a big part of which's office. So for example, you could take an office loan and remember these are that's going to be a big loans, that's going to be millions, you know, tens of millions of dollars. And then you take twenty or so other loans. Some of those are office loans, some of their some of those are loans on industrial properties, some of those are loans
on retail properties. And you and each of those is is producing regular interest payments every month, maybe millions of dollars. So all together, if you combine all of these loans, you've got it income streams Suddenly that's you know, that's worth a lot of money, and investors will pay for
that income stream. That is a CMBs when you combine the income streams from these different properties into a steady overall stream of payments, and the problem recently is that offices used to be a super safe part of this income stream that's going into these cnbs, and that's starting to change now they're no longer safe. There's there's big problems.
People don't really know how bad it's going to get, and it's making the lenders in the CMBs, the ones who are buying the income stream, it's making them very nervous.
Sounds a lot to me like two thousand and eight subprime. Should we worry about all that all over again?
I don't think we should worry about that. This is a fundamentally different space. I think if you go all the way back to subprime mortgages, that was some seriously risky loans for it, just to put it in perspective that I think the default right, So the share of those loans of prime mortgages, remember those are also much much smaller because they were individual borrowers that defaulted was you know, at the peak twenty thirty maybe forty percent or so. These are not going to have nearly the
same default, right. It's going to be below I don't want, you know, below ten, maybe five, I don't know, but not in the same universe. These are corporate borrowers, they're generally a little bit safer. Nevertheless, though you are seeing a little bit of an increase, and that's at a minimum. It's going to make people nervous.
I mean, it does sound particularly worrying when you've got all these big office buildings just sitting out there unoccupied. I mean, I travel around the United States and also Candada. Look at Toronto. I mean, it's just full of high rise buildings, a lot of them unoccupied. They're commercial and they can't be retrofitted, they can't suddenly be changed into condos. So what's the endgame here.
Nobody really knows. But I think one thing that everybody's talking about is how bad is this going to get for the banks. Banks buy a lot of commercial real estate, especially regional banks, that they're pretty exposed to commercial real estate. I'm not sure how exposed they are to this particular slice, which is CMBs, but there's definitely going to be some pain that. I think the top sort of national banks tend to be some of the biggest lenders of cnbs.
They're fine, They're obviously going to be fine, but they're still gonna you know, they're still going to be experiencing some pain over this. Then, so there's that the investors, the banks that are buying the cnbs or the lending into them, that are going to take a hit. And then it's going to be a lot harder for anybody who wants to refinance to refinance because rates are so much higher. Let's say you need to refinance an office loan, Suddenly you might not be able to afford it, and
that could be that could lead to some problems as well. Ultimately, I'm not really sure what's going to happen. I don't think anybody is really sure, aside from the fact that we do have this one big seismic trend rippling through the whole sector, which is people are not working in the office as often as they used to.
Are there any particular parts of the United States that are particularly exposed.
Yeah, you hear about some markets that are worse than others. Los Angeles is downtown LA. We had a great story by John Gidtelson a week or a couple of weeks ago about how Los Angeles office towers are really struggling. It's not viewed as a very attractive space, and that's where there's been a lot of defaults on office buildings. That was where that was where Brookfield defaulted on those
two LA office towers. That that catapulted this trend into the into the headlines, and then I think there have been a couple since then. Yeah, so I'd say LA is a is an area to watch and that that, in my mind stands out. There are a couple of others.
To be clear, when you're talking about investors like Brookfield, you know, these are big, deep pocketed investors. They're not struggling for cash, but they are effectually be walking away from some of these real estate assets that they own.
Yep, that's right there. It's it's you could call it a strategic default. It's not. It's not a default driven by they would really like to refinance. They just they can't. They don't have any money, so they have to. It's a default where they're saying it's just not worth it
to keep paying into this thing. So yeah, back in February, Brookfield was coming up against this big maturity date and it thought and it's and it decided, you know what, rather than refinance this thing and pay higher rates, we're just going to walk away. That made the most sense for them.
So before we talk to Louise Parker at Boomberg Contlligence, what's the next big story to watch here? Do you think, Scott?
Does it have to be related to to office US anything instructured finance, which tends to scare a lot of people generally, Well, everybody's looking at subprime auto loans. I'm working on subprime auto loans these days, for subprime model loans. The reason it's interesting to me is because they get
packaged into bonds, just like these office loans do. And what is going to the big question is what will happen with interest rates now being a lot higher and more and more subprime borrowers are falling behind on their payments. There's gonna be some pain for some bondholders who are exposed to people falling behind. It's going to be pretty limited, though there's a couple of deep subprime companies that are
that are more exposed than others. Overall, well, I think people are not fundamentally too worried, but yeah, there could be. There could be a little bit of pain for some of the more deep some prime borrowers. And if those loans get packaged into bonds, those bonds could be facing a bit of stress.
Very excited to see what you come up with on that great stuff. Scott the Carpenter from Bloomberg News, thanks so much for joining us.
Thanks very much. I read all of.
Scott's scoops on the Bloomberg terminal and of course at Bloomberg dot com. So, as I mentioned earlier, we're very pleased to have with us Louise Parker, who looks at consumer companies for Bloomberg Intelligence, and we're here to talk about the King of beers. What's the situation, Louise.
Well, h James or is it the king of beers? Certainly in the US in recent weeks, bud Light has lost its crown. It has been the number one beer in the US market for over twenty years and going back to early April in so a Twitter or not, Actually I think it was Instagram and Twitter post by a transgender I guess someone who had a marketing alliance with the company. She was celebrating her one year since transition and had one can of bud Light with her image on it, and the market for bud Light just
fell through the floor. In the world of social media, there was a boycott for bud Lights, and anytime customers are alienated by your advertising and the company says to their customers, this was not a marketing campaign. Okay, anytime you are in social media and you're paying someone to push your brand, that is marketing. That is a campaign.
The senior management behind the marketing alliance have been pushed aside, let's say, not necessarily sacked, but no longer in their positions, and senior management at AB InBev, who owns brand bud Light, having come out to say, we messed up. We made a mistake of just carrying on like nothing's changed. But now we're seeing in the numbers coming through from May that bud Light has actually lost its crown to be the number one beer in the US market to modelo
especial and interesting thing there is. But the ABI used to own that brand in America, but they had to sell it for concentration reasons when they bought sab Miller about six years ago, so they owned the brand Modello outside of America. But now it has the number one position in America. And as you and I were chudding recently, James, this is a cultural war. Now I don't reside in the US so maybe you can tell me what you're seeing on the airwaves about what's happening to bud Light.
Well, I live in the bubble of New York City and in particular Brooklyn, so everyone's drinking bud Light all the time. I prefer other types of alcoholic beverage, but other beers are available too. But why, I mean, this is fascinating exactly these say culture wars. But why are we talking about this on a credit show? Why does it affect the company so badly in terms of its revenue?
Well, it does because bud Light is such an important beer. Only they only generate seventeen percent of their total beer volume in the North American market, so that's US, Canada, and Mexico. But they generate that's volume, sales volume seventeen percent, but it's almost thirty percent, twenty eight point seven percent of sales revenue. And when you get to Ibida, that's where they're not some Bolts earnings, it's over thirty percent,
thirty point five percent. I'm not going to try and do a presentation here, but those numbers are coming down. So this is consensus are saying that volumes across North America, across all of their brands. Now they have a lot of brands which have also lost here. So they have not just bud Light, they have Michelo Vulture. They own Budweiser, bush Light, and Natural Light, and they had to also sell Corona, And so the brands that are gaining share
are the ones that they used to own. So any any brand that is not owned by ABI is actually gaining share. Add to the detriment of Bidlight and all of its sister brands under ABI umbrella. And what the analyst is saying this year is that North American volumes will be down five percent. That's in revenue, that's only one percent, But they're seeing North America ebit yards down eight percent. Now that's why I care as a credit analyst.
It's had a pretty dramatic impact on the share price for ABI bod in the US as the ticker is, but it's off its lows. It was down about seventeen percent. It's off the lows now, but the bonds spreads haven't really moved. So I care as a credit analyst. What's happening on the cash bonds The company has. ABI has bonds in sterling, euros dollars and I've looked at it this week against some of its peers in the beverage world, and they really haven't moved, they haven't widened, They've just
tracked the peer group for beverages. It is interesting for this company because they levered up five six years ago. As I said, when they bought sab Miller, they took on over one hundred billion dollars of debt. They've managed to reduce that down to about seventy billion and reduced leverage from upwards five times down to three and a half time. So they've just retained or just regained a single A credit rating. And it's great for the company
because they're in the market buying back bonds. The way they reduce their debt is tendering their their bonds. But now the sort of advanced situation where with declining earnings, they very well have to look at what the knock on effect to cash flow is. Will the bid for the bonds be supported by buybacks if their cash flow is indeed reducing? So that's why could and Less care.
But the equity is down and the bonds aren't. Do we expect the bonds to start falling in to catch catch up?
With the equity Eventually, yeah, really good question. Possibly we won't see the full extent of this, even though we get volume data on a week to week basis. The information industry informations out there and it's on the terminal for people that want to look at it. The company won't report their second quarter results until the first week of August, and that's when we might see them have to reduce their guidance. We haven't seen anything to date.
We saw when their first quarter came out, which was three weeks after this transgender influencer posted on Instagram, and they were like, well, North America's only once then have had volume with bud Light, it's not important. Well, I think they missed the point and they missed the opportunity to actually say, mere Copple, we got this wrong. We're
going to talk to our core customers. And they have rolled out new advertising, but the damage has been done, and some equity analysts out there are saying, will they ever get back the market share that they've lost. Certainly with bud Light, they've alienated customers and that's a real problem for a consumer company.
So one tweet loses them billions of dollars. The equity tanks the bonds could follow. Is it really as simple as that or was there anything else going on that you could attribute this move to.
I think it's a polarization of society in America. I mean, I'm sitting in London and or we just see what we see and we're obviously not on the ground there. This has not affected their global sales. This has not had a knock on effect to the London, Paris Frankfort. You know, they're beers, which we don't drink a little budde over here. I must say sorry about that. But they own cellar Atoa, they owned bets, they own left they you know, this is a global portfolio of beers.
It hasn't had a huge effect in South America, in Asia, Pacific, across Europe. This is a North America problem for the company and they have to address it. They literally have to come out and say this is what happened, this is how I fixing it. Sorry for the upset because people have boycotted this through social media and it's happening at the bars. They're having to repurchase beer that is expired because from their distributives, because the bars aren't taking it.
They can't sell it. So people are walking into a bar where they would have ordered a bid light, they're going for anything but an abi beer, and that is a problem.
It sounds like they're also a warning for other companies. I mean, there's lots of other consumer companies that you know, every time there's a special event or a commemoration or you know, it's Pride month this month. I mean, companies feel the need to make a statement on these things, on these issues. But then you're seeing this sort of backlash for for various reasons in the States. What's the strategy.
What do other consumer companies do they just keep quiet or they you know, how do others learn from this?
It's really hard joined because damned if you do, damned if you don't. I mean, my personal news feed is full of pride celebration, as you would expect for any whether you know, you get Mother's Day, you get fatherestay and the consumer companies roll out their advertising around that. And pride is huge because people celebrate, they get together with their friendship groups and they'll have a drink and that might be in a bud light, you know, you
never know, but they have to read the room. They have to see when they do misstep that they've made a mistake and they have to address it. Like they were trying to target a very small part of the population and alienated a large part of the population who actually uses their product, who drinks their beer. It's a really tricky question and.
They should have said sorry.
They should have said sorry.
Are there any other companies in this boat as far as you can see, Louise in terms of consumer stuff that you cover, well, I.
Don't cover target, but they were in a similar situation in recent weeks with again with Pride, they had special filmsuits for people who are transitioning, and mums yelled foul and said, you're targeting to In fact, they were not targeting children. Sorry to use upon the company they aimed target. They were not aimed at children. They were adult sized, and they moved all their stock to the back of the store and some stores just pulled the merchandise altogether.
So it's really hard when people are on a bandwagon. Do you swerve to your curve do you just avoid it all together? It's a really difficult one. But when you're in the business of selling a product, you are producing it. You have to sell you have to have the flow through of volumes or else you're having the shot shot down production. This is that's how serious it can get. If people don't take your product the end of the day, you have to consider what to do
with that product. Do we continue to ship the manufacture volumes and ship the volumes that we have been It's not you don't move beer from North America to South America, you know, you just don't. You have local brands, and you make those brands where where the consumer will consume them, where they'll drink them. And if they're not actually you know, asking for ad a bud light, that's that's troublesome.
And the Budweiser maker and Heiser Bush, that's they're still in trouble here. They're not out of the woods.
Not yeah, I mean this has been going on, as I said, since the beginning of April, and where what's troublesome for me is that this is the peak summer season that we're invented, and so families get together, you get together with your friends that we can you have a barbecue, you go for a picnique, you have you know, a callerbox. What if you call it ESQ on Australian of beer, wine, whatever other things you like to consume. And if you're avoiding one brand, that's an issue. You know,
people people might change their mind. But the social media over this is massive. I mean, I don't look at all this toff typically, but I did some research for this chat and it's it's just one way. It's there's a real.
Polarization total mindfield. Amazing, Yeah, very very interesting.
Thank you very much.
Louise Parker of Bloomberg Intelligence. Read all your great analysis Louise on the Bloomberg Terminal. Do check it out and we hope to see you back on the show soon. And thanks again to Scott Carpenter from Bloomberg News. Read all of his great distress debt scoops and strut to finance scoops on the Terminal and at Bloomberg dot Com. I'm James Crombie. It's been a pleasure having you join us again next week on the Credit Edge.