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Private Credit 

Chris Haffenden

The January effect is in full swing. Goldilocks investing strategies are in vogue, as weak survey data and lower inflation nos (note these are a rate-of-change time series) create January bulls from late December bears. European LevFin bankers finally emerged from their hibernation, with a raft of new issues and plenty of A&Es to boot for us at 9fin to analyse.

And as Deutsche points out, its been a stellar start to the year for most markets:

Best Euro Stoxx 600 return (+7.8%) in Bloomberg data back to 1987.

Best US IG (+4.5%) since daily data starts in 1999. If we use monthly data it would be the best Jan since 1975 if it ended now.

Best EU IG (+3.1%) since data starts in 1999.

Best start for the Hang Seng (+9.6%) since 1985.

Best start for MSCI EM Index (+7.7%) since 2001.

Best for US Treasuries (+3.4%) since daily data on Bloomberg starts in 1995.

Best for Euro Sovereigns (+4.7%) of 21st century so far.

On London Metal Exchange, best start for copper (+11.4%) since data begins in 1987, aluminium (+10.9%) since data begins 1989, zinc (+14.6%) since data begins 1990, tin (+17.3%) since data begins 1990.

Worst start (but better for risk assets) for European Natural Gas (-19.1%) since data begins in 2006.

So, yes there are reasons for new year optimism. Energy prices have fallen sharply (to pre war levels) and volatile index components such as rents and used cars have gone into reverse.

But expectations for rates and a recession are so elevated (or should that be depressed) — for me to ask, are traders getting too far ahead of the (yield) curve?

After the latest series of economic data, expectations are almost universal for a 25bps hike at the next FOMC meeting (futures are pricing in 27 bps), despite recent comments from Fed governors. Terminal rate expectations are around 4.75%, compared to the dot plots of 5.25-5.5%. As the year progresses the differential is even more marked, as the chart below shows.

To show how far we’ve come, US 10-year Treasuries are now 100bps lower than the 4.34% intra-day high on 21 October.

As a starting point, I would recommend Bloomberg’s Odd Lots podcast in early January on the improved chances for a soft landing in the US. One of the main takeaways for me is the Fed’s fixation with unemployment rates and wage inflation — which are stubbornly failing to move their way. As said before, rises in markets are easing financial conditions, meaning the central bank may have to hike rates higher and keep them raised for longer to deliver its stated objectives.

Or, as the market believes, the Fed will now have a change of heart, recognise that it’s all under control, and recalibrate its extreme hawkishness in the wake of weaker data.

Whatever you think, it’s a hell of a bet from markets that Sofr will be in the low 3s by the end of 2023,and it’s predicated on the view that we will be in recession and the Fed pivots.

But what recession? The differences between leading indicators and economic statistics are stark. It can be argued that actual data is showing the US growing at 4% or more (surely inflationary), whereas the lead indicators are all flashing red for recession.

One argument for the disparity is that inventories were built up in the summer as cost of living fears dampened demand, and they swelled further as supply chain conditions eased more quickly than expected. This has led to orders dropping sharply as these are unwound. As the economy normalises from the Covid funding splurge and supply chain distortions, spending is likely to shift from goods to services. Some of this is reflected in the latest survey data.

It’s too difficult for now to form a firm view, and take a few months to be clearer. But remember Goldilocks is a fairy tale, and brothers, it’s still grim out there.

Matalan has provided one such grim reminder. As Bianca Boorer flagged last Friday, the sales process undertaken by the first lien showed that value broke well into the first lien, leading them to choose their Plan B and to pursue their alternative recapitalisation plan.

The Monday morning release from the UK discount retailer provided some interesting details on why the FY 23 (ending March 2023) EBITDA would come in at just £30m compared to expectations of £76.3m previously. Matalan said it had misjudged inventories going into the key autumn and winter seasons and then had to discount heavily to clear stock. There is also the small matter of a £100m new money need.

Matalan claims recent woes are a one-off and cost and efficiency savings from its initiative with THG will bear fruit in coming years. It is forecasting the proverbial restructuring plan hockey stick recovery for 2024 to 2026.

9fin’s Emmet McNally is running his slide rule over revised forecasts and is delving into the potential recoveries — with some interesting findings — watch this space.

The company release, however, omitted any details on how the restructuring was going to be implemented.

After putting some calls into the advisors, we had our answer — the distressed sale mechanism under the intercreditor agreement.

This route has been rarely used of late, as companies typically prefer to use English Schemes and UK Restructuring Plans. There is, however, some sense in using this process for Matalan, and this explains why the first lien holders were so keen to run a marketing process.

Many intercreditor agreements have release provisions on enforcement. These include the release of security and guarantees by the security agent on a distressed disposal. To avoid abuse there are typically protections for junior creditors, such as the proceeds needing to be all or substantially all in cash, and at fair value, with the docs stating the methods of enforcement, etc.

Normally, either a competitive sale process should be run (this can be tougher than you think, as many third-party bids will be predicated on what deal you can secure from your creditors), or you can go via the valuation and fairness opinion route. Or you can do both, such as in Galapagos.

I remember its use for IMO Car Wash in 2009. I was partly responsible for the packed courtroom for their English Scheme (they had to move it to a larger one) after I ramped up its importance. It relied on a third-party sales process and a valuation from PwC which supported value breaking in the first lien. But the juniors fought this, with projections saying that value could return into their class. But their valuation evidence over-relied on a Monte-Carlo simulation which the judge quite rightly gave short thrift.

Another interesting piece of litigation is due to be heard in March, when Galapagos junior creditors are back in court. They challenged the UK jurisdiction in the past, with conflicting views on whether it should be heard here or in Germany, with various administrations and litigations across Europe, each claiming ownership over the process. Last March, the CJEU ruled on the COMI and last June a winding-up order was secured in the English courts for Galapagos SA.

A good summary on the various legal machinations is provided by Akin Gump, here

Now the focus shifts to a hearing in the UK, where the fair value protections on the sale proceeds needing to be all, or substantially all, in cash will be heard.

But back to Matalan, we are not hearing noises (or yet) that the second lien holders — whose £80m claim is written off under the restructuring — will seek to challenge.

An interesting email arrived in our inbox this week. An Ad Hoc group of GKN bondholders published their letter to the UK-based engineering group. They claimed that the company has ignored their arguments that a planned demerger where GKN Automotive and GKN Powder Metallurgy are separated constitutes an event of default under the docs.

The Announcement of the Demerger is clearly a threat that the Issuer will cease to carry on substantially all of its business or operations in breach of clause 9.1(d) of the EMTNs;

further or in the alternative, the Announcement of the Demerger is clearly a threat that a Principal Subsidiary will cease to carry on all of its business or operations in breach of clause 9.1(d); and

further, the Announcement of the Demerger has an analogous effect to a Principal Subsidiary ceasing to carry on all or substantially all of its business or operations in breach of clause 9.1(g) (together the “Events of Default”).

If they are right, and they have a legal opinion backing their claim, the EoD should be declared and the bonds repaid at 101. They say that the separation will cause them to lose the backing of a business which produces around two-thirds of group EBITDA. But is that substantially all?

If they fail on that issue, they may have a stronger argument on clause 9.1(d) given they will have lost a principal subsidiary in its entirety.

Even if the company did find a workaround to avoid triggering clause 9.1(d), then (g) is a catch-all if the transaction has the same effect as to trigger clauses 9.1(a) to (f).

So far the company has failed to engage with the bondholder group, advised by Kirkland & Ellis. The bonds have said they are set to enforce, which could lead to a directions hearing to resolve the issues. But first, our understanding is that they will seek to replace the incumbent trustee.

So with just £130m left outstanding after the company bought back a chunk of bonds in a recent tender at 87 (they were at 76 prior) why should we care?

Firstly, GKN is in the iTraxx Crossover Series 38 index. There could be considerable market interest in whether a CDS trigger event has occurred.

Secondly, holders that tendered at 87 could consider pursuing compensation if they unwittingly sold not knowing there was an event of default at the time — the bonds claim the technical default happens on the announcement, not when the demerger is effective.

Thirdly, lawyers have been eagerly awaiting legal precedents on the ‘substantially all’ wording in bond documents. We are told that GKN’s prospectus contains language which is fairly standard in non-HY MTN docs.

But there is also a chance that the company may decide to settle. After all the difference is a mere £25m, and GKN has sufficient cash. But for now they are not engaging:

“The claim is nonsense and we have told them it is nonsense,” a Melrose representative told 9fin.

We will take a closer look at the docs in the coming days to see if their claim does make sense. In the meantime we would welcome thoughts from our readers. Did anyone attend GKN’s investor day on Thursday and have the chance to collar management on this issue?

Last week we highlighted the difficulties in reaching agreement amongst Orpea’s diverse and divergent stakeholders.

CDC, the French state fund, had offered to put in around €700m of the €1.3bn to €1.5bn of new money needed by the French care home operator. But it wanted majority control. The Guns, an unsecured creditor group (with €1.9bn) could have potentially make up the difference, but the two parties were far apart on valuation. And then there was also the thorny issue of equity splits — not just between the two new money providers, but also the rest of the unsecured debt which was being fully equitised under the plan.

Other unsecured creditors, most notably the Schuldschein notes, were vehemently opposed to the restructuring plan. Orpea is likely to go down the Sauvegarde route if a consensual deal cannot be agreed via a court-supervised conciliation process led by the formidable Hélène Bourbouloux, and time is running out, with funding commitments due mid-January.

For those still looking to get up to speed on Orpea, Europe’s largest live restructuring, you can watch the replay of last Thursday’s webinar here

We were not surprised when L’Agefi reported yesterday that talks had broken down irrevocably on Wednesday evening. CDC had proposed with its local insurance group backers to inject €1.2bn with their alliance taking the majority of the equity, but without CDC itself having majority control. The Guns would put in €300m, but also wanted 9% more remuneration, claimed the paper. In another report from Les Echos, the paper said that CDC wanted to convert the unsecured debt (into equity) at 26% of face value, compared to 35% as demanded by the Guns.

The conciliation process ends on 25 February, and if there isn’t agreement, it could be converted into a Sauvegarde process, the article went on to say.

And after Thursday market close, Orpea confirmed the breakdown in talks with CDC.

“The Company notes with regrets that the respective expectations of the consortium of investors and the group of unsecured financial creditors concerned in terms of valuation do not allow to reach an agreement. Therefore, these negotiations come to an end.”

It adds: “the Company will continue discussions with the group of unsecured financial creditors whose support is required to reach an agreement on the restructuring plan.”

There is the potential for more bad news on Friday, with the ruling due for Mediobanca’s challenge to the conciliation process. As reported, the legal action was against Orpea’s first conciliation protocol and the second conciliation opening judgement. The bank is trying to obtain a nullification of the second conciliation and gain access to information for a lawsuit against Orpea.

After looking at Vivion’s debt and group structure after the German Real Estate group’s rebuttal to Muddy Waters report, 9fin’s David Graves released part two which looks at whether Vivion has fully addressed some of the questions posed by the short-seller relating to shareholder loans.

David also managed to speak to Carson Block, Muddy Water’s founder about his first foray into shorting a pure-play credit situation, saying that there are other untapped opportunities out there. Disparaging about dumb equity investors, he is much more complimentary about their bond peers:

“When you're talking about credit, and particularly when you’re talking about hard assets that underlie the credit, [the short thesis] does have to be profound, you do have to have a view that reality is significantly different from what perception is,” said Block.

January is time of the year that we review priorities, set new habits and stretch goals. In line with our New Year resolutions and in the spirit of out with the old and in with the new, we have made several changes to our Watchlist, with our latest edition of Watching the Defectives having all the details.

One recent addition to our expected deals list is Ideal Standard. 9fin’s Josh Latham suggests that the Belgian-based bathroom products group is in a liquidity crisis and may struggle to pay interest on 30 January. He and Alice Holian explore its options, including use of its docs.

This week we published the inaugural version of The A&E Waiting List — a new 9fin publication looking at amend & extend transactions. Some of these credits are under considerable stress, and may have structured their transactions with this in mind, aiming to achieve a soft restructuring or cut the debt load; others are the star performers in the leveraged credit universe simply looking to address maturities proactively.

With primary back in full swing and several A&E requests to analyse and rumours to confirm, our reading list is limited this week. Apologises in advance for being football heavy.

But first to Crypto, where my ex-colleague Rachel Butt (now at Bloomberg) has the scoop of yet another upcoming large Bankruptcy with Gemini set to file.

There was also an update on the FTX bankruptcy, but as Matt Levine remarked, the value of recovered crypto assets might also need a haircut as the size of the holdings would be significantly less in a firesale. But don’t worry, there is going to be more liquidity — the co-founders of bankrupt crypto fund Three Arrows Capital are setting up GTX (see what they’ve done there?) an exchange for crypto creditors to trade their claims!

Great piece from the Bond Vigilantes on the Swedish Housing Crash and if it is going to come to a housing market near you — the answer is, it depends.

I’m a big fan of David Allen Green on all matters legal and constitutional. He even manages to provide great insight into the offside law, after the critical decision in last Saturday’s Manchester Derby. 9fin’s lawyers will be horrified by the word ‘clearly’ inserted into the laws of the beautiful game.

Sticking with football, what a time to be a Brighton supporter. The Seagulls were 3-0 up against Liverpool last Saturday after 60 mins, as the Ole’s rung out as the team pinged the ball around the reds midfielders, in beautiful triangles.

But can we keep our team together? My son Charlie broke the news of the disaffected Leandro Trossard’s spat with manager RDZ, and he’s now off to Arsenal for a small profit.

What about Brighton’s other World Cup stars?

Moises Caicedo is a £75m target for Chelsea (we paid £4.5m in Feb 2021), and bids for Alexis Mac Alister will start at £50m (£7m in 2019). And what price Kaoru Mitoma (£2.5m in July 21)? I can’t wait for January to end, and to push for Europe with our squad intact.

BTW If we beat Leicester on Sat, we go fifth!

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