Update for Brookfield Shareholders as of 03/23/2020

Update for Brookfield Shareholders as of 03/23/2020

Dear Shareholders,

Given all the market volatility of the last few weeks, we thought it would be helpful to provide an update on where we stand as a company. No one is immune to the issues we are all dealing with, but as you know from our letters over the years, we have been expecting a recession and market washout for some time. Nobody could have predicted that the coronavirus would be the cause, but the markets sure turned over the last month.

As to our positioning and readiness for this, we believe we are in very good shape. We think it is important for you to know a few points:

• We have approximately $12 billion of bank lines in BAM and our four listed affiliates, all of which are very long-term, and importantly are all virtually 100% undrawn with global financial partners who we trust.

• We have approximately $5 billion of financial and non-core assets that can be liquidated with relative ease (even in today’s markets) should we so choose, to fund strategic investments or take care of issues. Many of these are hedged with index hedges so even if markets are down, this should offset marks that may come about due to the environment.

• We have only $7 billion of corporate debt (against an equity market cap of $40 to $60 billion – depending on the day) and none of that debt is coming due for many years. Similarly, in our private funds and listed affiliates, we have very little debt coming due over the next few years. To the extent that we have debt due, they are financings and mortgages secured by individual assets (which confines any impact to the asset). However, even in 2008/09 we were able to roll those over.

• We have no ‘hung purchases’. In fact, it’s the opposite – one way or another, every contested deal we tried to do over the past five months, we lost. We remained disciplined, which meant that we did not buy a number of businesses as their price rose. In hindsight, this was good.

• We just finished raising our latest funds and co-investments, totaling over $50 billion. These are only 40% invested, so we have a lot of capital to put to work in this environment. We also have the support of many leading sovereign and institutional investors in the world to augment these resources.

• We partnered with Oaktree last year in anticipation of the debt markets unwinding. Now it’s taking place. The team at Oaktree is accelerating the pace of deployment of their current distressed debt fund and preparing to launch their next fund, which we think could significantly exceed the size of their last. If this turns out to be the case, the addition of this business to ours will be very additive for us and our clients.

• Most of our businesses are very resilient, and we therefore don’t foresee major issues. Of course, with people staying home, business is slowing everywhere. In our operations, for example, our malls will be operating at a significantly reduced rate for a while (but this is a second derivative exposure as we collect rent, not run the stores, and our financing structures are in good shape), and fewer ships will travel to our ports. The bottom line is that while there are certain to be issues across our portfolio, our businesses are diversified, our financing structures are time-tested, and our resources significant to deal with this.

• Much of what we own around the world is critical infrastructure – across our property, infrastructure, renewable power and industrial businesses. We are working with governments and our employees to ensure that these facilities remain operational through this period. While many are at home now, people and companies still need corporate premises, infrastructure, power, broadband, utilities and many other critical services that form the backbone of the global economy, and that Brookfield’s businesses provide. Our teams are doing their best to ensure uninterrupted delivery of these services for our customers, while operating under difficult circumstances.

As to what we do now, here is how we are approaching this market volatility and uncertainty:

• Most importantly, we are staying calm and ensuring our people are safe. For us, compared to the direct hit we took on 9/11, this uncertainty and volatility feels manageable. In 2008, with the banking system failing, real asset owners didn’t know if many lenders were going to exist in the future. Today, the banking system is in far better shape. It never feels very good to have this degree of chaos, but this will pass.

• We are being vigilant and will continue to be disciplined. We will maintain capital for our worst-case scenarios. This is always very important, but even more so now.

• We have switched our focus for investments to the listed stock markets, and through our Oaktree franchise, the traded debt market. There are some stocks and debt starting to trade at a large discount to intrinsic value and we are focused on these. We are also starting to receive calls from companies in need of capital, and we look forward to being helpful to companies in need, where we can.

• Our shares have sold off along with everything else. We have been acquiring, and will continue to acquire our own shares for value when it makes sense – and in time, we are certain they will recover.

• Interest rates are now 100 basis points lower than they were a month ago. The value of many real assets is therefore higher, and our clients’ need for our offerings even greater. In time, this will all flow through to our assets and the valuations of our business.

Finally, a reminder regarding investing in times like these: the underlying value of a business that trades in the public market does not change on an hourly basis. Despite the fluctuations, you own a part of an actual business, not a piece of paper or electronic symbol that adjusts on a minute-by-minute basis.

Acknowledging that the value of some businesses has changed, at least in the short term (airlines being the most extreme example at the moment), the long-term value of many companies – i.e., the discounted stream of cash flows based on an estimate of growth and durability into the future – has not changed substantially over the past few months. The proviso is that a company must be able to pay its liabilities when due (stay solvent), which of course will be an issue for numerous companies in the absence of government assistance. Our focus has always been on structuring our affairs to ensure we can survive all environments, and we are confident we are in this position today.

Most of our cash flow streams are of very long duration with long-term property leases, long-term power sale contracts, and long-term regulated utility rates that provide durable business revenues with strong counterparties. As a result, the change in value of our businesses in the stock market over a few months has very little to do with the underlying businesses that you, as a shareholder, own. Please remember that you each own a portion of the investment management fees our business generates, as well as a portion of each of the durable businesses and assets we own.

It would be less distracting if we all owned this business together privately. That way you could read our materials, look at how each of our businesses is doing, observe the cash flows projected for many years, and not worry about how the stock market, with its short-term focus, values this information. We publish our views of how we value this business, and we encourage you to focus on these values over time (adjusted upward or downward as you see fit) and not on the stock price when volatility is at an extreme. In fact, the main reason to consider the stock price at moments like these is that it allows you to acquire a portion of our business at a large discount from its real value.

It is very easy to invest in the markets when times are good, but it is in times of market decline that following the tenets of value investing matters most. We encourage you to follow them. We know this is a very stressful time for everyone. Please know that we are watching out for your capital.

Be safe and please wash your hands,

Bruce Flatt

Chief Executive Officer

March 23, 2020

Coronavirus May Light Fuse on ‘Unexploded Bomb’ of Corporate Debt

Coronavirus May Light Fuse on ‘Unexploded Bomb’ of Corporate Debt

‘The corporate credit markets also are performing well, but we believe this is where the great value will be found in the next downturn. We are positioning ourselves to capitalize on this – both through our Brookfield funds, and through Oaktree.'

Bruce Flatt, CEO of Brookfield Asset Mangement, Feb 13, 2020

LONDON — To grasp why the most important central banks — from the Fed to the Bank of England to the Bank of Japan — are now leaping into action as if the world were on fire, it helps to examine the subject of corporate debt.

For years, wonks bearing spreadsheets have warned that corporations around the planet were developing a dangerous addiction to debt. Interest rates were so low that borrowing money was essentially free, enticing companies to avail themselves with abandon. Something bad was bound to happen eventually, leaving borrowers struggling to make their debt payments. Lenders would grow agitated, tightening credit for everyone. The world would confront a fresh crisis.

Something bad is now happening. As the coronavirus outbreak spreads, halting factories from China to Italy, sending stock markets plunging and prompting fears of a worldwide recession, historic levels of corporate debt threaten to intensify the economic damage. Companies facing grave debt burdens may be forced to cut costs, laying off workers and scrapping investments, as they seek to avoid default.

“We have been always saying that we are sitting on top of an unexploded bomb, but we don’t know what is going to trigger it,” said Emre Tiftik, director of Research for Global Policy Initiatives at the Institute of International Finance, a Washington-based financial industry trade group. “Can the coronavirus be a trigger? We don’t know. Maybe.”

By the end of 2019, total outstanding debt among corporations other than financial institutions had surged to a record $13.5 trillion worldwide, according to a recent report by Serdar Çelik and Mats Isaksson for the Organization for Economic Cooperation and Development, the Paris-based research institution. That number has swelled as many companies have sold riskier bonds to finance expansions.

Worries about corporate debt appear to be enhancing the panic that has captured world markets, as investors have dumped riskier assets like stocks in favor of safer holdings like United States government bonds.

This was especially vivid on Monday, as markets plunged in reaction to word that Saudi Arabia was driving oil prices lower. Many energy companies are dependent on riskier bonds. For them, lower oil prices translate into lower earnings. They may be forced to cut costs through layoffs or diminished investments to find cash to make their debt payments.

Concern about corporate borrowing also helps explain why the U.S. Federal Reserve last week opted to drop interest rates, and why the European Central Bank is expected to follow suit on Thursday. Lower interest rates limit debt payments for companies that might otherwise fall into trouble.

The concern about the magnitude of corporate debt is an outgrowth of how the world reacted to the financial crisis in 2008. Central banks from the United States to Europe to Japan pushed interest rates to zero and below, spurring companies to borrow and invest.

That approach ended the emergency, but also removed a source of market discipline: It diminished the risk of relying on debt.

Since 2008, corporations worldwide have issued about $1.8 trillion in new bonds each year, a pace roughly double the previous seven years, according to the O.E.C.D. Bond sales slowed in the latter half of 2018, as central banks lifted rates. But as central banks last year lowered rates anew, the debt binge resumed.

The International Monetary Fund last year examined the situation in eight countries including the United States, Japan, China and several European nations. It warned that a shock only half as severe as the global financial crisis would put nearly 40 percent of total corporate debt at risk, meaning that companies would not be able cover their payments with earnings alone.

Not everyone is sounding the alarm. “The prophets of doom who thought that more debt was more risk have generally been wrong for the last 12 years,” said Nicolas Véron, a senior fellow at the Peterson Institute for International Economics in Washington. “More debt has enabled more growth, and even if you have a bit more volatility, it’s still net positive for the economy.”

In contrast to the financial crisis of 2008, few today are worried about the banking system, which holds capital to cover bad loans. The best-financed companies like Apple, Google and Facebook have hundreds of billions of dollars in cash, making them essentially immune to whatever reckoning may lie ahead.

But even some who praise central banks for rescuing the world from catastrophe argue that easy money has outlived its usefulness. Years of loose credit have enabled weak companies to stave off extinction.

“There are whole sectors that survived that should have gone into restructuring,” said Alberto Gallo, head of macro strategies at Algebris Investments, an asset management firm in London. “Retailers in a world of online retail, energy companies with high production costs, small banks in Europe that are not efficient. The availability of funding at very cheap rates has kept zombie companies alive. This means we have an accumulated level of fragility in the economy which can be exposed very easily to real shocks.”

As the coronavirus has spread from Asia to Europe to North America, it has threatened the earnings of companies that have financed their businesses by selling riskier bonds.

The world of bonds can be roughly divided into two realms — those that gain the stamp of approval from credit rating agencies as investment grade, and those deemed to be less secure, bearing so-called junk status. Since 2010, about one-fifth of new corporate bond issuances have been below investment grade, according to the O.E.C.D. Last year, that proportion grew to one-fourth. “Default rates in a future downturn are likely to be higher than in previous credit cycles,” the report said.

Even within the sturdier category, bond markets have taken a pronounced turn toward risk: Last year, 51 percent of all outstanding investment-grade bonds were rated at BBB, the lowest level to qualify for that status, according to the O.E.C.D. That was up from 39 percent before the financial crisis.

That trend is troubling to financial experts because it leaves companies — and the world economy — especially vulnerable to a change in fortunes.

The world’s largest pools of money — asset managers that control pension funds, mutual fund operators, and insurance companies — are typically restricted in where they can invest. Many are obligated to hold the safest bonds.

When corporate bottom lines are threatened, credit ratings can be downgraded. Given that more than half of all investment-grade bonds now occupy the lowest rung of that classification, downgrades could render trillions of dollars’ worth of such holdings effectively radioactive. Money managers would be forced to unload them while buying safer assets. That would make credit tighter for many companies, threatening some with insolvency and constraining economic growth.

This was the situation before the coronavirus began its lethal, wealth-destroying wander around the globe. The widespread disruption to factories across Asia and in Europe, the effective quarantining of all of Italy, and the spread of the outbreak to the United States have threatened the earnings of thousands of companies.

Last month, Kraft Heinz, the maker of ketchup and other processed foods, had its debt slashed to junk status. Macy’s, the department store giant, as well as the carmakers Ford and Renault, have also suffered downgrades.

Fitch Ratings, the credit rating agency, last week said that one-fourth of the corporate bonds it tracks in Europe have been issued by companies impeded by government actions meant to limit the spread of the virus, like travel restrictions and bans on public gatherings.

Companies dependent on Italy appear especially vulnerable.

Poste Italiana oversees mail delivery while also selling financial, insurance and telecommunications services. The company’s debt is rated BBB. No great powers of imagination are required to grasp that the sequestration of the nation is going to stop customers from reaching post offices.

“We’re going to look at all cost-reduction measures,” the company’s chief executive, Matteo Del Fante, said in a recent presentation to analysts.

Before the outbreak arrived in Europe, CNH Industrial, which makes machinery for construction and agriculture, was cutting expectations for earnings, citing weak demand in North and South America. As of the end of 2019, it carried debt of nearly $25 billion. Its bonds are mostly rated BBB, and Italy is the source of one-tenth of it sales. Those facts seemed unlikely to bolster confidence.

History shows that perilous pressures can build for years inside major economies without disaster unfolding. Danger signs frequently turn out to be benign. Perhaps the wave of corporate borrowing will subside without a traumatic event to right the balance.

But if a nasty reassessment of risk lies ahead, bringing an economic crisis, the coronavirus outbreak could be the event that sets it in motion.

“This is exactly the type of thing that can trigger a chain reaction,” said Sonja Gibbs, managing director of Global Policy Initiatives at the Institute of International Finance. “The vulnerability in the corporate debt market has been building up for a very long time.”

Peter S. Goodman, The New York Times, reporting from London, England

Peter S. Goodman is a London-based European economics correspondent. He was previously a national economic correspondent in New York. He has also worked at The Washington Post as a China correspondent, and was global editor in chief of the International Business Times. @petersgoodman

Website

https://www.nytimes.com/2020/03/11/business/coronavirus-corporate-debt.html

Buying the Apocalypse

Buying the Apocalypse

Remember the Speculator’s Edge…to demand supply and supply demand. Doing your job as a speculator sometimes requires buying when there’s blood in the streets or under other circumstances when all but the bravest are selling. Indeed, the best trade (investment) imaginable would be buying stocks at the Apocalypse. You’d get them while their worth less than their intrinsic value (value of future cash flows discounted back to the present). The discount rate is the yield on the ten year bill (the risk-free rate) which is now under one percent…Therefore those future cash flows will be discounted by very little...In other words think long term where there is less competition for the information that really matters. And remember at times of emotional extremes, be contrary. Don't be part of the herd...stand apart!

A few reassuring words from Bruce Flatt from his latest letter to the shareholders…

While we manage our underlying business for the long term, we realize that you are also interested in our stock performance. Its 50% increase in 2019 was an anomaly; at the same time, the previous year the share price was down, which we also viewed as an anomaly. We estimate that we earned approximately 20% annual returns on our intrinsic value over the two years. As a result, over the two years combined, our stock had a return that was about the same as what we generated in the business.

In short what is now happening in the stock market is an anomaly. The run-up up to the current sell-off was an anomaly…Focus on long term values…hold your nose and buy or just hold on to what what you have. Stocks that have a history of raising their dividends will beat the hell out of the returns one can get from putting his money into the ten year bill where your return will be currently less than one percent for the next ten years...think about it.