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Chris Haffenden

Markets are at an inflection point. US stocks and High Yield spreads have retraced around 50% of their 2022 sell-off - despite many observers seeing little value at these levels given the negative macro backdrop - as central bankers continue to talk in hawkish tones.

This has led to a tussle between those aggressively fighting the up move seeing it as massively overdone with on the other side algo and momentum buyers buoyed by the price action and willing to fight the Fed, forcing hedgies to cover as prices hit key resistance levels.

It feels as if a sharp move is coming – but in which direction – that is the 4300 question

The positive narrative is that US inflation has peaked, rates should hit a terminal rate of 3.25% in the first quarter, a recession is inevitable and central bankers will be forced to pivot and cut rates in the second half with inflation – mostly driven by energy – coming back below 4% by then.

The negative narrative is the Fed is willing to trade a sharp recession to tackle stubbornly high inflation and reduce economic imbalances. Terminal rates are likely to hit 4% or more. Despite recession fears, the economy runs hot, with other factors such as low unemployment and wage pressures mean that even if energy and commodity prices cool, other forces will keep CPI high.

It is also worth noting that if markets continue to rally, the consequent improvement in financial conditions means that more tightening (monetary and fiscal) could be needed from the Fed:

For most of this year, there has been a strong correlation between the US HY index and the S&P 500. If the former is indeed leading, could we now see a reversal in US stocks?

Or is it the old adage of the market inflicting the greatest amount of pain on the greatest number of participants going to play out with yet another sharp squeeze higher?

Whatever your view, there is a growing disconnect between Europe and across the pond in US.

UK and European inflation continues to rise with monthly numbers continuing to surprise to the upside. One of the main reasons for this is the huge increases in energy prices, most notably gas, and as well as food as the hot dry summer takes its toll on agriculture

On Wednesday, German power prices hit a record high of €516 per MwH. For context this is double the level seen in March after the spike from Russia/Ukraine, €300 higher than two months ago and 10x higher than seen 18-months ago. UK CPI hit 10.1% last month, with food prices rising by double-digit amounts. The next quarter or two is going to get a lot worse for European consumers and for manufacturers with high energy needs.

European and the US LevFin markets are also diverging

We have seen decent margin and spread compression in both markets, but primary activity is still mainly in the US. Any company with global operations and/or dollar needs must go stateside.

It is not just the greater depth in the US market, but savings are to be had for borrowers too.

This was illustrated earlier this week with Solenis’ new dollar Senior Secured Note (SSN) issue. When checking our relative value chart on our Credit QuickTake edit, I thought that we had an error in our pricing feed or for the yield/spread calculation for their 2028 USD SSNs.

While yields to worst of Solenis’ two outstanding SSNs – one in USD and one in EUR are similar, on a spread to worst basis (US rates are markedly higher) it is a whopping 230 bps difference.

Another notable difference is the spread between the senior secured and junior bonds in both currencies. In dollars the SUNs are trading at more than double the spread of the SSNs (800bps versus 380bps) a 420bps differential, whereas in euros it is just 230bps between the two.

NB the difference between the secured and juniors at issue was much closer at 150bps for the euros and 200bps for the dollars.

A real conundrum. Perhaps price thoughts for the new dollar SSNs – interestingly, one year shorter than the outstanding SSNs – could provide insight. We thought the old dollar SSNs were locked away with buy and hold accounts, with the new paper offering a nice switch. It seemed that way when price thoughts emerged at 7.25-7.5%, an enticing 100 bps pick-up to the existing.

The deal ended up pricing at 7.125% at 99 to yield 7.36%, still a decent pick-up, but 312 bps inside the dollar SUNs for a name as Kat Hildalgo reported has plenty of fans and an easy name to like following recent ‘brilliant’ earnings for the pool and water treatment chemicals business.

That evening I was discussing Solenis over a beer with a HY analyst – a big bull on the credit. He said that the reason why their dollar SSNs trade so well is convexity - buyers want the low coupon as it gives more price appreciation if spreads and rates compress. The 50bps pick-up for a much higher coupon bond gives a higher running yield but with a significantly lower convexity it might not be enough to compensate, he suggested. Conversely, if you think rates are headed higher and spreads are adequate, the new issue will provide better protection.

The wideness in spread between seniors and juniors is due to high leverage and LTV – with little equity cushion, he noted. But with a double-digit yield surely these are the bonds to play in.

Convexity-driven demand was another topic of discussion as we sunk our second beer.

While single-B borrowers might still need to offer near double-digit yields to get their deals away, HY investors prefer deep OIDs to higher running yields he said. CLOs are also keen to take advantage of the discounts available to engineer pull to par, to mitigate lower average prices on other bonds in their portfolios which they held since issue but are trading below 90.

But with a significant recovery in spreads and rates in the past six weeks, surely there is a risk that funds might be setting themselves up for fall if we see another correction as the convexity will hurt harder than with par paper?

Preference for lower coupons and OIDs is a relief for borrowers seeking to keep annual interest costs down. But even so, those borrowers who left it too late to refinance will still have to pay almost double the interest from before.

An example is Norican, as we outline in our latest (Not so) Blessed to be Stressed report. Its past integration issues appear behind it and the rationalisation plan has helped to generate decent positive cash flow, with net leverage just 3.3x. Its €340m of SSNs are due in June 2023 and as 9fin’s Ben Hoskin outlines issuing €390m of debt with 7.5% coupon with a ten point OID would double the existing cash interest costs and would be nearly half of FY 21 operating cash flow.

Admittedly most HY borrowers took advantage of a hot market to refinance in 2020 – according to 9fin data €144bn of European HY issuance was refinanced between May 2020 and June 2021 - but we still have 229 bonds maturing in the next two years with 103 trading above 99, which suggests confidence that they will be taken out.

Of this subset, 41 have coupons less than 3% - so many of these will see their interest costs more than double. For those trading below 99, 31 bonds have coupons of less than 3% - many will struggle to afford higher interest costs, perhaps it’s time for financial advisors to get creative.

In late June, I highlighted the value in SSNs in Europe, most notably in sterling, with number of names at double digit yields. In the downdraft, the spread differential between the seniors and juniors remained too tight, you were not getting paid for the additional risk and lack of security.

At the peak of the market, some borrowers such as Asda achieved remarkable prints for their SUNs – at a remarkably narrow 75bps to the seniors for their jumbo HY deal last year.

Issued at 3.25% and 4% respectively with total net leverage of 3.5x (2.9x through the senior secured), Asda’s leverage has increased to 3.9x after a poor first quarter which saw revenue and adjusted EBITDA fall 9.2% and 32% YoY respectively. Coupled with rumours the Issa Brothers were going to pile further debt on Asda to fund their bid for Boots (given a lot of latitude under the bond docs) their bonds cheapened up significantly in June and July.

On a yield differential basis, the spread was 250 bps when the bonds hit their price low point.

On a spread to worst basis, at the worst absolute spread point, the spread differential was 260bps. But after the recent impressive price recovery, this widened to 315 bps. The juniors have lagged markedly, which might be surprising to some readers. Their results are due next Thursday - if you were to position yourself ahead of the earnings, where in the cap stack would you play?

In our Top of the Flops this week, we took a look at spread differentials for a number of names between their senior secured and juniors, of varying levels of stress/distress.

Douglas bonds missed out on the latest rally, spreads between the SSNs and SUNs remain wide:

This month’s worst performer Groupe Casino has seen the relative spreads widen slightly:

For more distressed names such as Diebold, the latest recovery has seen the spreads compress sharply, but the SUNs still trade 20 points below the SSNs in the low 60s and yield north of 40%.

From an initial analysis it is difficult to divine a pattern or work out where value lies. Should you look at LTV (to work out the equity cushion and downside risk), use spread per turn of leverage, or use something else? There will always be issuer specific criteria too, such as latitude to issue more priming debt, sponsor strength, etc. We would be interested in readers thoughts.

Going back to our transatlantic SSN comparisons, it is not just Solenis with a marked difference in spreads for different currencies. Allied Universal shows the better value on offer for its non-dollar paper, trading at almost 200bps wider.

On a yield basis, there is little in it between dollars and euros, but it also shows the premium needed for sterling issuance with narrower pool of investors:

Similar to Solenis, its chemical peer, Polynt’s euro SSNs are 230bps wider on a STW than their dollar peers, but they trade at almost identical yields to maturity.

These are just a few examples, but while on an absolute yield basis your return is the same, on a risk-adjusted basis, there is so much more value in Europe. Surely this can be arbitraged via currency swaps and CDS? Could we see US investors shopping for bargains in Europe?

This Monday we released our latest edition of Top of the Flops. After the latest rally in European LevFin prices, which saw the iTraxx Crossover dip back below 500bps for the first time since early June, many of our flops saw the largest price flips.

The magnitude of the rally is shown by the number of bonds which have risen by over 5% since Mid-July - a massive 602 bonds from 202 issuers. Amazingly, we had 141 bonds from 86 borrowers up by more than 10%.

On a monthly basis, only 15 bonds from 10 issuers were down by more than 5% - the biggest movers shown below:

So, what effect has the sharp rally had on the number of bonds trading at stressed and/or distressed levels?

As at 12 August we had 188 bonds from 136 borrowers as stressed/distressed - down from 248 and 168 a fortnight earlier, with Victoria Plc the only new entrant into stressed.

The number of stressed bonds almost halved from a month ago to 117 from 90 issuers, compared to 211 and 138 in mid-July. This is down by 50 and 28 respectively from end-July.

Casino (poor results), Victoria Plc, Intralot 24s (after refinancing of 2025 PIKs) and Tullow Oil (merger doubts) were among the worst performers.

Whereas TDC (refinancing news- our analysis of its options is here) and aircraft lessor Avolon (strong rally since 26 July results) were among the strongest performers:

Moving onto distressed, we have 70 bonds from 51 issuers - down from 107 and 76 a month ago. Just Tullow Oil has entered into the distressed camp.

Amongst our distressed borrowers, we have seen some strong rallies in some of the more beaten up names, such as Lycra, Matalan, Diebold Nixdorf, and Maxeda.

The recovery in loans prices was arguably even more impressive than bonds. From 297 in mid-July and 178 a fortnight ago, just 133 loans are trading below 92. The worst performers over the past month were GenesisCare (our latest update is here) and group.ONE.

In total 77 loans are stressed, priced between 85 and 92. The largest positive movers in the stressed camp were beaten-up names, such as Hurtigruten and food names such as Cerelia, Euro Ethnic Foods, and Ecotone.

We have 56 loans trading as distressed - priced below 85, down from 77 a month ago. There were few fallers in past two weeks, with GenesisCare and Labeyrie the most notable.

On the flip side, we saw some solid gains from cinema operators Cineworld and Vue, and similar to bonds, from recently beaten-up names such as Rohm, PDA and Tarkett.

Cinema operators similar to cruise line operators have had a choppy journey since the start of the Covid pandemic. Forced closures during lockdown and restrictions during reopening have meant it taking much longer than expected for cinemagoers to return in their pre Covid numbers.

Many had to take on emergency financings to tide themselves over, often close to or over double digit rates. The film studios were quick to switch to other platforms and with other structural shifts as Disney, Netflix and Apple making their own films and releasing direct to streaming, there are concerns that Cinema businesses would struggle to survive.

If that wasn’t enough, the Cinema operators had spent heavily in moving upmarket, revamping their theatres, and making large acquisitions, and were poorly prepared for what was to come.

There was a brief interlude last year when some were bailed out by Redditors as the meme stock craze took hold. AMC fully embraced it and with a number of gimmicks managed to build up a $2bn war chest taking advantage of retail investors attracted by free popcorn, NFTs and probably worthless crypto tokens.

Despite an impressive summer run with bumper audiences, the high debt figures and poor economics have finally taken their toll on the movie mavericks.

Vue was first to enter into a process, with its English Scheme of Arrangement due to be sanctioned at the end of August. First lien lenders will take control of 100% of the equity in return for providing £75m of new money and writing off £225m of the £775m of senior debt. In total £465m of existing debt will be written off, including the second lien and shareholder loans which will be wiped out.

This week Cineworld announced it was in discussions with lenders to “potentially restructure its balance sheet through a comprehensive deleveraging transaction.” Shareholders should expect a very significant dilution- does that mean that remarkably they might retain a stake – or will Redditors ride to the rescue? Today the £134m market cap has collapsed to €40m (at time of writing).

It blames a limited film slate until November and potential $1bn payout to Cineplex after it reneged on an acquisition announced pre-Covid as reasons for a restructuring.

Some advisors are expecting a similar script to Vue, but our understanding is that it likely to happen stateside. The company side FAs are working on it from their US offices and a Chapter 11 filing would provide a worldwide stay on enforcement and likely push Cineplex into an unsecured claim. The vast majority of its debt is also in US hands.

Our previous reporting is here and here – we will look into their options in the coming days. Their loans are trading in the low 60’s.

Upfield Flora produced the surprise of the week, with butter than expected Q2 numbers, being able to spread price rises onto buyers more thickly than most had expected. The plant-based food and margarine producers €685m 5.75% 2026 SUNs jumped almost ten points on the release. As 9fin’s Emmet McNally says:

The headlines are positive - pricing delivered a turbo boost to the topline, Europe is starting to catch up, margins are recovering, FCF was in the green and the outlook for H2 22 points to de-leveraging driven by nominal growth in normalised EBITDA. Some near-term risks that were previously priced in will potentially be averted, but the fact remains that there is a considerable refinancing risk and bonds prices still in the low-to-mid 70s are indicative of this.

Another topical name PDA reported this morning. The numbers weren’t pretty: sales rose slightly up 2.5% YoY, but EBITDA fell 51.7% YoY and leverage rose by 1.3x to 6.3x. Earlier in the week, in our deep-dive report we had cautioned that the Netherlands-headquartered manufacturer of domestic appliances faced an uncertain future in light of macro and geopolitical headwinds and the effects from the cost of living crisis. 9fin’s Emmet McNally said:

Credit metrics are currently understated and will remain so until at least 2025 on account of ongoing standalone or carve-out-related spending. On balance, we suggest the near-term risk profile for the bonds and TLB in PDA’s cap structure is weighted to the downside.

Prosol, the Ardian owned French Fresh Food chain, has seen a ten-point rebound in secondary since dipping into mid-70s in mid-July. Buysiders speaking to 9fin are split on the name, some are looking to increase their stake, drawn by the long dated 2028 maturities, reliable sponsor, and its Grand Frais’ chains market position. More bearish peers are concerned about tough upcoming quarters given a rise in raw material prices, high expansionary capex spend and an expected decrease in margins. Leverage could hit double digits in FY22, leaving little margin for error.

Technicolor has returned to its former banking syndicate to finance the spin-off of its TCS special effects division, reports 9fin’s Lara Gibson. Debt advisors from Rothschild pitched a ~€620m equivalent four-year TLB at E+600 bps and an OID in the 95 range, the sources told 9fin. The facility is composed of two tranches, a €563 million tranche and a $60m dollar tranche.

Rothschild opted not to widely market the deal, persuading former lenders to reinvest. The new financing should push TCS’ leverage to around 3.7x, based on forecasted 2022 EBITDA. Despite Technicolor’s patchy history - less than two years from its debt restructuring - buysiders are relatively optimistic about TCS’ recent performance with one noting that TCS is the jewel of the former Technicolor operations.

As confidence returns to stock markets, it is back to meme stocks. This week, we saw a sharp rally in the stock of nailed-on restructuring candidate Bed Bath & Beyond.

The FT subsequently disclosed that a university student has made $110m on the trade - mostly financed by friends and family.

Perhaps Jake Freedman should be hired by restructuring and financial advisory firms. As our friends at Petition suggest:

If it can last and it can help potential chapter 11 debtors avoid the bankruptcy bin a la Gamestop Inc. ($GME) and AMC Entertainment Inc. ($AMC), then perhaps firms ought to, like, pay more attention to this potential growth area?!? We know: this seems bonkers but if achieving meme stonk status is the latest and greatest bankruptcy avoidance mechanism, shouldn’t restructuring firms perhaps invest in capabilities there?* All it might take is hiring some smart MBA students with experience running a meme account and the sky is the limit.**

As Elon Musk joked about buying Manchester United (surely a bigger gag that suggesting buying a dog shaped crypto token) and Jim Radcliffe looks for another team for Ineos to sponsor, our favourite football finance blogger the Swiss Ramble is back with another great thread

In a past life I was a sovereign debt trader, and have retained an interest in sovereign restructurings ever since. Former US Treasury and IMF official Mark Sobel says in the FT that Sovereign debt architecture is messy and here to stay.

One of the latest EM borrowers to approach the IMF is Ghana. As this excellent Economist article notes, Ghana has spent 22 of the past 35 years under the funds supervision. Ghana is where most of Tullow Oil’s operations are and this week the UK-headquartered African E&P company bonds were downgraded in line with the Sovereign, amid concerns over currency controls. With Ghana strapped for cash, I suspect it will also push hard for the disputed £400m of tax too.

It gives me an opportunity to reprise ‘Never Ghana Give You Up’ - apologies to Rick Ashley:

We’re no strangers to debt sustainability

A full commitment underwrite is what I’m thinking of

You wouldn’t get this from any other SSA

Your RFPs still outstanding but you’re too shy to say itI

nside we both know what’s been going on

We know the game and we’re Ghana play it

Don’t tell me you’re too blind to see the debt-to-GDP

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