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Chris Haffenden

While I was away for the past couple of weeks executing my lifestyle amend-and-extend, rates fears were rising, with the problem getting very real for many borrowers, including governments. 

Attention is on disorderly deficits with, as The Economist reported last week, the IMF’s Serkan Arslanalp and Barry Eichengreen of the University of California, Berkeley, presenting their views on how governments can reduce them, at the annual Jackson Hole summit. 

From my experience as an Emerging Market Sovereign trader, I know that the main levers to reduce government debt are to run primary surpluses (before interest payments) — a difficult feat given that the US is currently running a deficit of 8.6% (way higher than would be comfortable for an emerging economy) — or to inflate it away, as the rate of economic growth exceeds the inflation-adjusted rate of interest.

The latter has been the main hope to reduce the Covid-induced debt splurge, but as The Economist points out “inflation only reduces debt when it is unexpected. If bondholders anticipate fast-rising prices, they will demand higher returns, pushing up the government’s interest bill.” The article further noted: “Persistent inflation helped after the second world war only because policymakers held down nominal bond yields in a policy known as financial repression.”

Inflation is no longer unexpected nor transitory, and this week, real rates in the US were fast approaching 2%, their highest level since just before the global financial crisis hit. 

It is worth noting that historically, real rates have been significantly higher, and for a prolonged period of time (see chart above). If higher for longer persists, the real rate may rise yet further. 

And its not just happening in the US, the European five-year/five year forward euro inflation rate is currently 2.35% (it turned negative in 2014 after the ECB started QE to de-anchor inflation expectations below its target) and is also at its highest level since just before the GFC. 

So how does all this translate into demand and pricing for risk assets?

As Credit Agricole traders Samy Ben Aoun, Matthieu Thévenet, and Nicolas Randazzo note in a Risk.net article:

“With real interest rates as the transmission channel, changes in the inflation outlook over time influence the risk premium and price dynamics of risky assets.”

A negative real rate environment often reflects an abundance of liquidity, reduced risk premia with associated inflation in risk asset prices as investors go in search of positive returns, which is exacerbated when nominal interest rates are also negative. 

Conversely, positive real interest rates reflect reduced liquidity, higher risk premiums and result in deflation in risky asset values. 

This means that risk premia for holding risky assets should already be on the rise. 

But this doesn’t tally with where we are with high yield and lev loan pricing, with risk premia remaining low historically. As discussed in previous Workouts there are positive technicals at play, but these tailwinds could be abating. It is notable that the European corporate bond market reopened in September with a splurge of IG deals and strong BBs in EHY and few single Bs. 

One area where we are seeing higher nominal and real interest rates playing out is at the weaker end of the credit spectrum, with the dispersion between good and bad credits widening sharply. 

EHY CCC paper is now yielding over 16%, from 12% in February, whereas BB yields are holding in well. I would note that 18% of the CCC index is Real Estate (5% is Adler!) and recoveries this year are coming in well below historical averages. 

High real rates encourage savings, leaving less money to go into riskier financial assets. In periods of high financial market uncertainty, real interest rate volatility can be as much as 1.5x that of nominal interest rates, note the Credit Agricole rates traders. 

This could mean that we see some interesting moves at the margins for risk assets in the coming months. All things being equal, high real rates could increase corporate debt burdens over time, as companies are unable to inflate them away. 

Some of you at this point will be saying there is a third lever to reduce debt burdens — growth. If this is faster than the real rate then ratios will come down. While a soft landing is still preferred by many, few are expecting economic growth rates of 4% and above in the medium term. 

And what about stagflation? This could be extremely damaging when debt burdens are so high.

It may be too early to say that inflation has been conquered. Oil prices this week surged on the Saudi cuts, and are up 25% since June. The US strategic reserve is at historically low levels making it hard to intervene. Could prices squeeze above $100? 

Celsa steal for creditors (if you believe the family owners’ valuation) 

While I was away, the Celsa judgment landed.

It is a significant and landmark victory for creditors whose restructuring plan was finally accepted by the Spanish Courts, after a protracted valuation fight with its shareholders. 

The politically-sensitive steelmaker has been at odds with its creditors since 2017, when the controlling family rejected a debt-for-equity swap that would have seen KKR taking control of the business. 

Instead, Celsa’s debt was restructured into an Opco/HoldCo structure, with a €900m OpCo jumbo loan paying between 3% and due in 2022 and €1.25bn of HoldCo convertible debt paying 11% PIK due in 2023, which in addition to being convertible to equity, could be elevated and converted into bank debt based on a 4.25x leverage test as part of a rebalancing agreement — which was subsequently triggered. 

But income then collapsed during the pandemic and Celsa asked (and failed) to secure agreement from bank lenders to suspend amortisation payments. It then controversially used the courts to enact an arcane “rebus sic stantibus” clause “allowing the debtor to be released from or lessen the negative impact of a contractual risk that was not assigned at the time of the entering into the agreement, and that materialises due to the existence of extraordinary and unforeseeable circumstances which are not attributable to either party.”

The case was eventually overturned in January 2021 by a Madrid court, bringing creditors back to the table. By this time another stakeholder was added into the mix — SEPI, the state fund set up during Covid to support the solvency of strategic companies with an application for a €550m loan. This placed creditors at odds with the company and the state fund over the use of proceeds whose disbursement was conditional on a deleveraging agreement. 

Fast forward to last September. The SEPI funds were yet to be disbursed and the loans were in default after failing to repay at maturity. So creditors, at one minute past midnight (after the new Spanish insolvency law came into effect), filed their restructuring plan. 

Taking advantage of the new cramdown provisions and the ability for creditors to submit a plan without company consent, their proposal involved a debt-for-equity swap for all of the €1.25bn (€850m outstanding) convertible debt and 15% of the jumbo debt for 100% of the equity.

But the shareholders weren’t giving up without another fight. 

The Rubiralta family argued there was significant equity value, putting the value of the business at €6bn versus €1.8-2.8bn as determined by a restructuring expert appointed by the court, ahead of a 3 July 2023 hearing. They said promotors of the plan would receive a value greater than the amount of their credits. 

This Monday, Judge Alvaro Loberto Lavín in the Commercial Court of Barcelona handed down a 156-page judgment — available here in its original Spanish and here translated into English — well worth a read. 

The judge said that the company reports from PwC and Laínez (used to justify the lofty €6bn valuation) “reach the erratic conclusion that Grupo Celsa is solvent because they eliminate all financial debt from the equation by remitting to a limbo, previously designed by the debtor, the amount of two thousand three hundred million euros that Grupo Celsa owes to its financial creditors. Once the debt is amputated through this kind of "accounting surgery," it can be concluded, as the PwC solvency report does, that "Group Celsa Spain as of the date of analysis (March 31, 2023), does not show any indication of insolvency or just point out that "Currently, the Group has a debt with the current Jumbo lenders, whose amount and degree of future enforceability is pending judicial resolution."(Laínez Report).”

Lavin was also savage in PwC’s assessment that the Jumbo and Convertible credits “are of litigious nature, [and] for this reason they would be comparable to credits under a suspensive condition, therefore, the aforementioned credits cannot be enforceable, nor they can be considered expired until the suspensive condition is met, that is, until a final judgment is issued or the procedure is terminated.”

Sticking with his medical similes Lavin said in his judgment “it is as if [in giving] a diagnosis a doctor conclude(s) by stating that the patient is in very good health because he presents excellent analytical results, but his heart has stopped working.”

He added that the litigious nature of a credit does not emerge automatically and spontaneously from a unilateral initiative of a debtor exercising legal action. He said to later convert a litigious credit — ”which it is not” — into a credit through a spurious application of the bankruptcy law “is a new step into the abyss.”

The result of the conclusions reached by the two reports are highly surprising, said Lavin. “The consequences that would follow would lead to the catastrophic collapse of the credit markets.”

Perhaps a little over-egging the omelette, but I’m liking his prose. 

“When there is an elephant in the room one has to see it, especially if he claims to be an expert in the field.”

“Really, it's about an astonishingly categorical statement and that causes a certain perplexity, because the expert does not provide any data that allows contrasting or corroborating his thesis that seems to reside in his most intimate conviction, a kind of "ontologist's secret" whose deciphering is forbidden to all those not initiated into some mysterious ritual.”

I had an interesting meeting with the European head of a large global hedge fund this week. I was primarily there to talk about distressed debt, ahead of a conference panel, but as he explained, this is only 10% of the firm's capital deployed, and it has been their worst performing strategy. 

The focus is now on risk-adjusted returns, pushing the ability to provide numerous capital structure solutions, and even co-invest alongside existing sponsors. No time for aggressive loan-to-own strategies and navigating difficult jurisdictions. 

Better to stick to sectors they know best and have the expertise and capabilities to deal with, rather than trying to play in say cyclical building materials credits, he said. For example, the fund has a large real estate focus and even owns a RE lender, which is seeing great opportunities in providing senior secured debt at up to 50-55% LTVs at attractive margins, rather than play in Adler Group’s new 21% PIK 1.5-lien bond issue. 

When our conversation switched to NPLs, debt purchasers and debt servicers, he was scathing. He quipped that NPLs stood for — ‘no private life’ — explaining further that managing and working out the loans took up too much time and didn’t deliver outsized risk adjusted returns. 

Many of the debt purchasers aren’t businesses but more of a collection of individual trades, whose time and arbitrage ability has gone, similar to German RE firms once being able to fund development assets at below 5% yields, he added. 

As my colleague Owen Sanderson in June outlined in his explainer on debt purchasers: 

“They’re a financial play, with businesses built around buying intangible assets low, and selling (or collecting) high. That means they need a fundamentally different analysis lens.”

And therefore it pays to have a variety of funding sources, and not be too reliant on one, in particular the more fickle HY market. 

Lowell, Encore and Arrow can use securitisations (revolving basis, or using re-performing assets) to keep their costs low, and maintain the spreads. But Intrum and in particular AnaCap have much less flexibility and will find it difficult to purchase new NPLs to replenish their books — either from a funding or competitiveness standpoint. 

9fin’s Nathan Mitchell outlines in his detailed AnaCap analysis piece of last week, that its business model is the redeployment of collected funds into new investments at a targeted money multiple. This, at least is intended to, create a self-sustaining asset book in which cash flow from collections covers operating expenses, financing costs and capital re-deployment. When rates increase the margin between the NPL purchaser’s cost of financing and expected portfolio return falls, limiting cash flow to creditors and debt capacity.

But with the bonds trading in the 50s, does this matter? Surely the ERCs (the estimated remaining collections) are enough to cover the bonds as they roll off? 

Unfortunately there is a fundamental flaw with this analysis. Management’s 68.5% LTV uses an undiscounted gross ERC figure, ignoring the cost of collections — which are rising fast, as the low hanging fruit has already been dealt with. 

Discounting the expected net ERC (using 30% historical cost of collections) by 20%, the present value of the business at FY23 is €302.5m, which equates to a LTV of 122.1%. 

As AnaCap is cash strapped and facing significant upcoming debt maturities (including an RCF in December), therefore it is unable to buy new NPLs, leading to the proportion of direct real estate in its portfolio rising fast. 

As of Q1 23, direct real estate made up €287m (53%) of 84-month ERC, spread across the UK (48% of 84m ERC), Italy (36%), and France (16%), mostly consisting of office (49%) and retail (25%) properties. 

Real estate requires higher capital expenditure when compared to servicing and managing NPLs. 

In order to begin generating cash flows from ‘value-add’ and ‘development’ properties (collectively 54% of 84m real estate ERC), renovations and/or repairs must be made to the asset therefore requiring additional cash investment upfront. To combat this, AnaCap will often pre-sell the acquired real estate asset while completing any redevelopment to de-risk the investment with day-one cash generation, which in turn can be used towards funding development costs.

The TLDR is that Nathan believes the bonds are trading at levels consistent with his run-off bear case scenario, illustrated below:

While RCF lenders are unlikely to want to tip AnaCap into a firesale of NPL and RE sales, we don’t think an A&E is possible without support from elsewhere within the group and/or from its LPs, with a full blown restructuring a much more likely scenario. 

While the situation is small and is unlikely to entice many financial and legal advisors to pitch for a mandate, the outcome could be important for the bigger players who may suffer the same fate. 

A big squeeze in Altice complex bond prices yesterday, as a series of local press reports suggested that owner Patrick Draghi — in town this week for the Goldman Sachs and JP Morgan conferences — may pursue asset sales or raise equity to de-lever the business. However, the non-deal roadshow and one-on-ones provided little new information, two investors told 9fin.

If you first don’t succeed try, try, try and try again. After numerous requests, the determinations committee ruled on 6 September that Groupe Casino has triggered a failure to pay credit event. It cited the company’s announcement on 25 August as a key piece of evidence. 

“As an update to its noteholders, the Casino group indicates that the President of the Paris Commercial Court (Président du tribunal de commerce de Paris) will rule in September on requests for grace periods (délais de grâce) relating to (i) the senior unsecured notes issued by Casino, due 2026 and 2027, (ii) the EMTN notes due 2026, and (iii) the TSSDIs issued in 2005. For the time being, the President of the Paris Commercial Court has temporarily suspended all payment obligations in respect of these notes.”

This will be a relief to unsecured bondholders who bought protection, given that their notes are indicated in low single-figures!

Our editorial team has been trying to decant information on Accolade Wines for weeks. Recently advisor-ed up, the House of Arras brand sale may buy time ahead of an upcoming restructuring. Its 2025 term loans are not ageing well, stuck in the mid-30s. 

While the number of stressed earnings releases was less than in recent weeks, there was still enough for our analyst team to get their teeth into. 

One of the most eagerly awaited was German RE business Demire, which said on its 4 September call that it is in discussions with mortgage lenders and capital market lenders to raise secured debt to help address its €600m+ near-term maturity wall. Disposals remain the key strategic pillar of the maturity wall strategy, and management was bullish about the prospects for the re-marketed LogPark asset in Leipzig. Demire reached an agreement in December to sell the asset for €121m, a 14.5% discount to FY 21 book value. 

Disappointment for Kloeckner Pentaplast investors as details of its equity injection from sponsor SVP were revealed. It only injected €130m of fresh capital into the OpCo, with a €12.5m shareholder loan write-off and €7.5m TopCo injection rounding out the balance. As 9fin’s Emmet Mc Nally writes “the TopCo piece was to cover “certain expenses incurred by KP” including “board expenses”. SVP has extracted plenty of value from KP already (more here), but this so-called injection seems contentious.”

What I’ve been reading, watching in past fortnight

Primary has returned, so much of my reading this week has been OMs and NetRoadshows. 

One FinTwit analyst wasn’t impressed with one of the attendees at the GS event on Monday:

Yet more educational content on social media on Real Estate structures, here is a great primer on the use of preferred equity in the cap stack (not sure the disclaimer is needed in this chart!)

As part of my lifestyle A&E, I’m now an owner of a large Volvo Estate. Despite having a rear camera, its been a big adjustment for parking (it just fits a standard space, apparently 56 vehicles sold in the UK don’t!) Hyundai’s Ioniq 5 prototype crab walk piqued my interest.

I was unable to attend Brighton’s victory over Newcastle last Saturday due to a fixture clash. It was also my wedding date. 

Scheduling nuptials at 3pm on a Saturday in early September wasn’t optimal. TV demand meant that the game was moved to 5.30pm, and while there was a TV at the reception venue (Chez Haff), having the game on would have probably have been grounds for divorce. 

Our 18-year old Irish striker Evan Fergusson netted a hat-trick in a 3-1 win, pushing his valuation close to three-digits.

We also had the Europa League draw. Fans can travel to Amsterdam (Ajax), Athens (AEK) and Marseilles, in a group which is arguably tougher than many in the Champions League. With the games kicking off at 8pm on Thursday evenings, this is another potential fixture clash, I can normally be found at this time trying to get the Friday Workout over the line. 

No time to crow about the Ansu Fati loan from Barcelona, I will leave that for future editions.

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