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 early warning signs that could predict the contagion that was about to unfold. A possibility? Junk bonds from Coinbase Global Inc.

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The largest US digital asset trading platform has seen the price of its bonds fall this year. At the beginning of January, the price for one of the most active notes was about 92 cents. It then dropped to around 77 cents in April before dropping to 63 cents amid the Terra Luna market crash in May. The bonds were trading around 53 cents on the dollar — a level typically associated with distressed — during early morning trading in New York Wednesday, according to Trace bond trading data.

The drop is largely attributed to the so-called crypto winter that has leveled digital currency markets this year. But for some industry participants, the plunge was a portent of the carnage that would soon be unleashed.

The crypto exchange’s debt can be described as a “canary in the coal mine,” credit analyst David Havens of Bloomberg Intelligence said in a telephone interview. In particular, “something that really grabbed attention” in May was Coinbase’s comment that customers could be treated like general unsecured creditors if the company went bankrupt.

This surprised many people and, according to Havens, raised several questions: “Bankruptcy? What they saw, heard and felt compelled the lawyers at the time to include that statement,” he said. And second: “Customers. Wait what? We are perhaps pari passu to bondholders, not segregated as in a regular exchange?

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

It contributed to the fall in bonds and turned out to be one of the indicators of things to come.

The yield on Coinbase’s bonds is currently between 13 and 15%. “We believe this fully reflects ongoing crypto uncertainty and negative technicals, with few buyers willing to step in with what remains of 2022,” Havens wrote in a note Monday.

“The bonds reflect the animal spirits that are currently going on,” he said in the telephone interview. “And that is the fear that has engulfed crypto.”

However, any recovery in debt could, according to Havens, be an early signal that the market is beginning to thaw. “But so far it’s been a painful ride,” he said. “We’re at a bit of a tipping point.”

Debt claim imminent?

According to Havens, there may 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 such as Bankman-Fried’s FTX and Changpeng “CZ” Zhao’s Binance.

“Coinbase should buy back every possible bond right now to demonstrate their commitment to a reasonable balance sheet,” added John McClain, a high yield portfolio manager at Brandywine Global Investment Management. “Leverage has destroyed many of their competitors and they have a unique opportunity to cut leverage very attractively.”

Marty Fridson, long-time high-yield bond analyst, also shares a more positive view of the downgraded bonds. Fridson, who is chief investment officer at Lehmann Livian Fridson Advisors LLC, thinks that according to a Nov. 15 PitchBook analysis, the BB rating of notes traded at distressed levels, including Coinbase, is better described by their rating level. than their current price.

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

“By contrast, I estimate the average one-year default rate of distressed issuers over the period from 1997 to 2021 to be 38%, suggesting a huge discrepancy between a BB rating and a distressed valuation,” he wrote.

The yield on Coinbase’s bonds is currently much higher than the 7.1% average yield that trades debt with similar ratings. That, too, suggests a dislocation between the price the market sets for the debt versus how solid a bet is according to credit rating agencies.

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

It’s hard to buy anything crypto-related — except maybe crypto companies 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 dive

Bullish stock 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 fall. Meanwhile, debt has risen from the lows reached earlier this month.

Year-to-date, stocks are down more than 80%, while Bitcoin is down about 65%. At Tuesday’s close, the stock was estimated to need a staggering 782% rally to reach their 12-month average price target from early 2022.

Elsewhere in the credit markets:

America

General Electric Co. announced that approximately $9.3 billion in dollar-denominated bonds have been validly tendered and not withdrawn on or before the early participation date as part of its recent tender offer.

  • Rite Aid said about 33% of eligible bonds were tendered by an early deadline following a proposal to purchase as much as $200 million of its 7.5% senior secured bonds due 2025

  • T. Rowe Price Group Inc., the $1.3 trillion global asset manager, is cautious on US corporate debt given exposure to the Federal Reserve’s overly aggressive policies

  • Three-month London interbank offered interest rates for dollars climbed to the highest level since the financial crisis on an otherwise quiet day for the front-end of fixed income markets

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

  • For more, click here for the Credit Daybook Americas

EMEA

Borrowers accumulating in 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 about 6.3 years, the lowest since December 2018.

  • Wednesday’s issuers included Severn Trent in the UK market, while Continental AG, GSK Capital and Liberty Mutual Group offered euro-denominated deals

  • Foreign companies seeking cash in a niche market for German debt could receive a lukewarm reception from would-be lenders stung by the scandal of French care home operator Orpea SA

  • Indices that track the cost of insurance against defaults by European companies were on track for their lowest closing since June

Asia

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

  • Chinese developers are issuing more bonds under a state guarantee program, suggesting an increase in government support to ease the sector’s liquidity problems is paying off

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

–With help from Yueqi Yang.

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