Daily Agenda: Dollar Optimism Batters Commodities

New Fed rules push banks to reduce scale; Toshiba CEO steps down amid accounting scandal; Novartis and IBM earnings show y-o-y slump.


Ty Wright

The rout in commodity markets continued overnight. Gold and silver extended their losses and front-month West Texas Intermediate crude oil futures fell below $50 per barrel, reaching a multimonth low. A perfect brew of a rising U.S. dollar, slack supply and sluggish demand from China and other developing markets have cast a pall over the entire asset class. According to a report released last week by the Commodity Futures Trading Commission, institutions are holding more bearish positions than bullish ones for the first time since 2006. Not all analysts agree that the selling pressure will continue as the Fed begins tightening, however. In a note to clients last week, Jesper Dannesboe, senior commodities strategist at Société Générale in London, recommended that client buy a basket of smaller London Metal Exchange-traded base metals, saying that the sell-off may be overdone and that “a 15–20 percent price gain in the value of this basket over coming months seems plausible.”

Fed releases new capital regulations. The Federal Reserve unveiled a new rule yesterday that will require the eight largest banks in the U.S. to have additional capital. In a signal that the central bank is seeking to encourage lenders to reduce their size, Fed policymakers allowed General Electric to opt out of the new requirements by agreeing to halve its financing unit.

Accounting scandal wracks Toshiba. An independent investigator has concluded that Japanese consumer tech giant Toshiba had overstated earnings by roughly $1.2 billion over the course of six years with the knowledge of CEO Hisao Tanaka and his predecessors. Both Tanaka and Norio Sasaki, the company’s vice chair, resigned today as the company issued a statement expressing apologies to investors.

Novartis guides lower. Basel–headquartered pharmaceutical company Novartis released second-quarter earnings today that showed a significant declined versus the same period last year and reduced sales forecasts for its Alcon eye treatment brand. The company reported that increased competition and a surging U.S. dollar had lead to deteriorating prospects.

IBM sales decline again. For the 13th consecutive quarter, Armonk, New York–based technology company International Business Machines Corp. reported declining sales as a strong dollar drove revenues 13.5 percent lower than during second-quarter 2014. The company continues to grapple with cloud-based competition to its hardware divisions.

Portfolio Perspective: New Regulations a Boon for BDCsGrier Eliasek, Prospect Capital Corp.

Business development companies (BDCs) may enjoy astonishing growth over the next few years, thanks to new regulations stemming from Basel III, the Dodd-Frank Wall Street Reform and Consumer Protection Act and leveraged lending guidelines. These will restrict the banking industry’s leveraged lending abilities, thus creating opportunities for BDCs to fill the void, according to New York–based financial services firm Cantor Fitzgerald.

Under Basel III, banks face stricter capital requirements, which will deter them from holding leveraged loans on their balance sheets. The Office of the Comptroller of the Currency, the FDIC and Federal Reserve all issued leveraged-lending guidelines that will curb deposit-taking establishments from holding risky assets, including highly leveraged loans. Over the past decade, collateralized loan obligations (CLOs) have been a key lender to middle market companies. But CLOs will likely stop lending to midmarket firms when Dodd-Frank’s new risk retention rules go into effect at the end of next year.

Against this backdrop, GE Capital — the largest lender to middle-market companies — recently said it is leaving the commercial lending business. This leaves a void that BDCs could fill. BDCs have excellent credit quality and should remain in good standing given expectations for continued economic growth for the foreseeable future. At the same time, BDCs’ net interest margins will benefit from a Federal Reserve interest rate hike that’s widely expected later this year. BDCs borrow at fixed, short-term rates while lending at long-term floating rates.

The large amount of private equity capital sitting on the sidelines should boost mergers and acquisitions. As this money is put to work, it has the potential to stoke demand for financing and deals for BDCs. Private equity firms have $466 billion in uninvested capital on hand, according to Cantor Fitzgerald, citing data from the Private Equity Growth Capital Council. Cantor Fitzgerald believes a portion of this capital will be invested into middle-market firms. All private equity deals use leverage and BDCs are best positioned to provide the needed financing.

All the while, low BDC valuations make for an excellent value and income investment over the long term. BDCs are trading at a price-to-book ratio of 0.88 versus their historical average of 1.16. The industry currently trades at 9.3 times net interest income, which is lower than their average of 10.5 times net operating income. Current dividend yield of 9.4 percent is on par with the average of 9.5 percent.

Grier Eliasek is the president and chief operating officer at Prospect Capital Corp., a firm that provides private debt and equity capital, in New York.