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Chris Haffenden

Last week, I questioned whether “we are in for a period of slow growth, with a shallow recession at worst and/or stickier and higher than inflation than first thought? Think Stag, not Bull or Bear”. 

I added that “may mean elevated rates for longer, a return to historical level of defaults and less abnormally high returns”.

A plausible scenario is that US and eurozone inflation may struggle to drop below 5% (well ahead of 2% CB targets) keeping rates higher than current core CPIs — which in many cases is ticking up again. This means the rate of increase in prices and probably wages will outpace economic and revenue growth. If revenue growth is slower than increases in interest costs this will reduce debt service coverage ratios and will be yet another driver for corporate distress.

And as last week’s US debt ceiling talks highlight, it is arguably even more difficult for sovereigns as their bloated debts arising from pandemic spending are rising faster than tax receipts. This reduces fiscal options to deal with a protracted economic slowdown.

Going through a raft of FY 22 and Q1 23 earnings releases in the past few weeks, it is clear that many EHY borrowers have targeted improving/rebuilding margins, but this is often at the expense of sales volumes — Upfield Flora is a great example here. 

As leading indicators turn negative and customers ask for reversals in price pass-throughs, this could be the best quarter of the year for many borrowers. From now on, the shorter contract lengths and pricing indexes negotiated over the past year work against you rather than for you. 

We will soon see which issuers locked in their hedges at the high points (Canpack, KP) and which ones took the risk of not doing so, and now look savvy. Then there are those which got their projections wrong and were left with high involuntary inventory paid for at elevated prices (Arxada). 

Our friends at Deutsche Bank Credit Research team appear to agree with me that defaults are on the rise and are likely to be higher than many analysts think. In their Credit Default Study — 2023: Return of the Boom-Bust Cycle(email jim.reid@db.com for a copy) they say that their cycle indicators signal a default wave is imminent. 

“The tightest Fed and ECB policy in 15 years is colliding with high leverage built upon stretched margins.”

Deutsche’s team predict that defaults will peak at Q4 24 at 9% for US HY, 11.3% for US Loans, & 5.8% for EU speculative-grade. There is unlikely to be a Covid or GFC-style shock, but the Boom-Bust cycle is likely to return. Tight financial conditions have produced the highest 24m-36m forward US Loan and EHY and European LevLoan maturity walls in eight years, they note. 

But the primary driver for most defaults is not maturity walls but unsustainable capital structures. And busting some myths about high equity cushions, the median US HY issuer debt to EV at 46% is slightly worse than seen in Q3 2008, notes Deutsche, and that’s before you get into all that pro forma adjusted EBITDA malarkey we’ve seen in recent years. 

Moving into Europe, in bonds it’s clear where all the perceived distress lies, with Real Estate (5% of total issuance) making up over half of EHY distressed debt, with Retail second in the high teens.

But arguably, loans are even more interesting, with some of the previous industry darlings such as Software and Healthcare (even more elevated in Private Credit space too) pricing in the highest levels of distress, with Food Products, Media and Consumer Staples also elevated.

And, arguably, bond and loan prices are not pricing in the elevated risks. If there is a recession in the next calendar year, Deutsche says that its “default forecast would likely see a cumulative five-year default rate above long-term averages, which would put CCCs and Single-Bs at risk.” 

I would also add that upcoming recoveries should be lower than historical averages given presence of cov-lite structures (late triggers often lead to worse outcomes for creditors) and loose docs allowing for more value leakage and more inter-creditor shenanigans. 

The Deutsche report also goes into a lot of detail on implied defaults, spread implied default rates and much more. But it’s the end of the week and time to look at current defaults. 

Deutsche’s timing was impeccable, with two defaults coming in the week that their excellent report was released. 

First was Diebold Nixdorf, the troubled ATM manufacturer, which filed for Chapter 11 and a Dutch Scheme on 30 May. 

As 9fin’s Emmet McNally writes it “brings to an end a tumultuous eight months for Diebold, during which it has already been through a stressed A&E (more here; deal data here) which included the replacement of a restrictive RCF with what was intended to be a better suited ABL facility.”

But just a few months later it ran into trouble as the borrowing base on its new ABL fell below expectations, leading to an approach to lenders to secure a new temporary $55m FILO tranche to support liquidity and seek a waiver from lenders on capacity constraints (more here). 

This led to a cliff edge, which it eventually fell over after it failed to exchange $72m of stub 2024 SUNs or take them out with fresh equity (despite several deadline extensions).

A restructuring support agreement has been agreed with 80.4% of its $401m superpriority term loan, 79% of first lien loans, 78% of first lien notes and 58.3% of second lien notes. There are sizeable backstop fees available for a $1.25bn DIP financing facility. There is 27% post-petition common equity available to the backstop committee, comprising a 13.5% backstop premium, a 6.5% upfront premium and a 7% additional premium.

The DIP facility is available on a pro rata basis to all superpriority and first lien lenders with a 10% equity participation premium on offer. Proceeds will be used to pay down in full the $401m superpriority (SPTL) facility plus a whopping $90m make-whole premium, to repay $238m of ABL facility drawings (inclusive of recent First In Last Out tranche), to cover costs and fees and for working capital needs and general corporate purposes.

Reflecting the winners and losers from its previous stressed A&E, its superpriority term loans are unimpaired under the plan, but recoveries for first lien and second lien and the stub notes are poor. According to the disclosure statement for the pre-pack plan, first lien claims have a projected recovery of just 33.3% - 43.5%, with the second lien and stub notes set to receive 4.1% to 5.4%

The euro-denominated senior secured notes dived 56 points after the news, indicated at 20-mid, in-line with the dollar notes. The second lien PIK toggles plunged 35 points to two-mid! The (dissenting A&E) stub senior unsecured notes are deeply out-of-the money, at one-bid. 

GenesisCare’s Chapter 11 filing yesterday was less surprising, as my colleagues will confirm that I had predicted this fate over a year ago. The loans had traded down in the 20s in recent weeks, and we reported in February that liquidity was likely to run out in 2023 if the cash burn trajectory continued. The troubled US operations, due to its acquisition of 21 Century Oncology out of Chapter 11 in May 2020, are mostly to blame for the poor performance. 

Owned by China Resources (36%), KKR (30%) and doctors and management (34%), GenesisCare operates around 440 clinics in Australia, the US, Spain and the UK. The business expects to continue to operate as normal throughout the Chapter 11 process, which will see its US operations separated from the rest of the group.

“The path to a GenesisCare US turnaround will take time and capital, and the GenesisCare enterprise currently does not have the wherewithal to make such investments,” wrote CEO David Young in his submission to the US Bankruptcy Court for the Southern District of Texas.

The company has received commitments from existing lenders for an $800m debtor-in-possession (DIP) facility, including $200m in new money (of which $90m will be immediately available) and $600m will be a roll-up facility.

Its shareholders last year extended the maturity of their loans until November 2023. The loans were originally meant to be repaid from proceeds from the disposal of GenesisCare’s Australian cardiology business. Together, the disposal proceeds and loans totalled around $108m. However, this was insufficient to stem fast diminishing liquidity, with liquidity of just $54m at end-December 2022 compared to $154m at end-September 2022.

GenesisCare’s term loans, already indicated at deeply distressed levels, dropped sharply on the news. The company’s euro-denominated loans due 2025 and 2027 were hardest hit, falling from an indicative price of 26.35-mid to 10.25-mid, according to 9fin data.

The most interesting aspect of GenesisCare’s filing was the alleged actions of some of its revolver lenders, which it blamed for a lack of liquidity runway and one of the reasons for its Chapter 11 application. 

In his statement, CEO David Young said that GenesisCare sought to draw on the A$121m ($79m) available under its RCF in April — sufficient liquidity through to August 2023. However, the company only received A$44m ($29m) as some lenders refused.

“The draw-down requests were funded by nine institutions on a timely basis, but were unfunded by the remaining four unnamed banks, who held a majority of commitments under the RCF without justification, other than requests for voluminous diligence that were not required to be provided under the Senior Facilities Agreement,” wrote Young in his declaration.

He also noted that, following the refusal, GenesisCare loosened the restrictive white list on its TLBs, and secured a change of governing law on the loans from English law to New York law, in order to increase the debt’s liquidity — bringing new lenders into the fold who would be supportive of the DIP financing.

I’m no loan lawyer and not familiar with the mechanics of RCF utilisation requests. But it appears they were trying to argue there was a possible default and/or repeating reps didn’t apply. 

“The Defaulting Banks, through their counsel, Linklaters LLP, declined to fund the Utilization Requests citing the RCF Debtors’ lack of explanation or advance notice to the RCF Lenders, neither of which the RCF Debtors were obligated to do under the Senior Facilities Agreement. In the same correspondence, the Defaulting Banks demanded that the RCF Debtors, among other things, withdraw the Utilization Requests, provide responses to extensive information requests, set up meetings with the Company’s senior management team and the Defaulting Banks, provide written confirmation from the RCF Debtors’ directors that they are acting in good faith, and engage with the Defaulting Banks with respect to a potential refinancing transaction.”

Whether this will be debated further in the upcoming hearings will be interesting. We still await the first day hearing, but will be closely monitoring the dedicated Chapter 11 website closely.

We welcome any thoughts from restructuring lawyers on this. 

A day earlier, another company, in less dire straits, also took the rare stance of openly referring to its RCF lenders in public, albeit more cryptically. In Kloeckner Pentaplast’s Q1 23 earning call, following an unexpected €150m injection from its sponsors SVP Global, management said it had drawn down €134m of its €150m 2025 RCF during the first quarter because of concern around the “continuity of some of the banks” in the syndicate.

The facility is not about to be rolled (it matures in 2025). Credit Suisse is one of the five banks on the deal, but it is unclear whether the comments relate to UBS being unwilling to step in when the forced merger completes. There is a 40% sultans of springer at 8.9x, but covenanted leverage was 6.9x as at Q1 23, so there was plenty of headroom and no urgency to draw. 

As 9fin’s Emmet McNally reports, a chunk of the €150m injection (coming in by end-June) will go towards to paying down the €134m of drawn RCF, given projected €70m of levered FCF in Q2-Q4 23. If half of the €150m injection used to pay down the remaining RCF drawings, as management has guided to nil drawings by year-end, that leaves €85m or so capital to deploy.

Buying back the SUNs in the mid-60s is one option, as it would prove more de-leveraging than secured debt. Using €85m of funds to repurchase the SUNs at a 35% discount could reduce the principal by €115m or de-leverage the balance sheet to 7.3x from 8x as of Q1 23.

But that would leave a top senior heavy debt stack, so a combination is more likely, we think. 

As Emmet notes, KP was 6.9x levered through its secured debt or 8x levered inclusive of the SUNs as of Q1 23. That SVP was prepared to inject capital into such a high-leveraged capital structure is a good signal that the sponsor sees equity value in the business. This is perhaps not overly surprising, as the business should command an EV multiple in the 9x - 10x area. 

If the business is able to boost LTM EBITDA from €260m to €400m as projected, and deliver €300m plus of FCF, the balance sheet would deleverage to around 4.75x and leave 5.25x or €2.1bn of nominal equity value at a 10x multiple on €400m EBITDA, money for nothing? 

I may be looking closer than usual, but I did recognise more companies were drawing down on the revolvers in the first quarter. Notable names included:

Standard Profil (with another CS — or should that be CS-led €30m RCF) which drew down €27.5m of the €30m which helped boost its cash balance to €18.3m to €27m. We note there is an undisclosed minimum liquidity covenant attached to the RCF for the automotive seals supplier. 

Arxada (Lonza speciality chemicals) drew down on its RCFs (yes, it has two!) again in the first quarter to preserve liquidity levels. As 9fin’s Alexandros Chatzigiannis writes the Swiss specialty chemical business delivered a disappointing Q1 23, struggling to deal with softening demand across all its major business units, combined with a lack of short term “visibility.” They are now CHF 70m drawn compared to CHF 40m drawn in Q4 22, with another CHF 153m available. 

Arxada is one of the newest entries in the stressed category in the latest edition of Top of the Flops, published on Thursday. Its dollar and Euro TLBs fell into the mid 80s in May. Despite little change in headline stressed/distressed numbers there was a significant churn in new entrants for both bonds and loans in the Flops, perhaps reflecting disparity in Q1 23 and FY 22 earnings. 

In addition to the usual Floppish activity, in the latest edition, we look at stressed/distressed borrowers that have yet to address their maturities (under two years), and the re-rating of debt collectors — subhead you just haven’t earned it yet baby — one of many The Smiths references (following on from the positive response to the Radiohead mentions from last month). 

Let us know how many you can spot — no googling mind.

Talking of debt collectors, my colleague Owen Sanderson noted in Lowell’s FY 22 release on Wednesday that it had been unable to obtain an audit, with KPMG Luxembourg offering a “disclaimer of opinion” based on missing documentation for 12 line items, mostly in the Germany/Austria/Switzerland region, totalling £339m (though across both sides of the balance sheet). Group management said that this was because of rebuilding systems following a cyber attack incident last year. This may be deja vu for some readers, it was just over a year ago that the same auditor issued a disclaimer of opinion for Adler Group, which resulted in back and forth if this constituted an audit and if not, an event of default under their bonds. Lowell’s 2025 SSNs were little changed, but are already yielding over 20%, and are worth a closer investigation. 

Serial scoopster Sky’s Mark Kleinman, was one business day out in his exclusive on Asda’s purchase of the bulk of EG Group’s UK&I operations, announced on Tuesday (not Friday) in conjunction with Asda Q1 23 earnings. Our initial take is here. Debt prices for both rallied on the news, probably due to property-related financing doing some of the heavy lifting and a larger equity (and equity equivalents) cheque. We query whether this is really leverage neutral for Asda, using pre-IFRS 16 accounting as you are contributing right of use assets here. The term loan debt package (reportedly from Apollo) looks pricey at 11% all-in, and why not from its incumbent banks? Watch out for a more in-depth report in coming days. EG Group is reporting next Thurs. 

My suggestion in last Friday’s Workout that someone might seek a determination on Groupe Casino’s CDS after its conciliation filing last Thursday proved accurate, with a general interest question being submitted. 9fin’s CDS expert Dan Alderson is sceptical that this will be successful, but the DC have accepted to hear it and will meet on Friday to deliberate. Last Friday we outlined an outlier scenario — if the term loans and RCF move to the new TERACT French Perimeter and the unsecured get cashed out at a discount or exchanged into a new entity — you could be left with no deliverables. This isn’t our default position, but an interesting scenario nonetheless. 

Tele Columbus management said this week, that they had narrowed down their refinancing options to two, and that some form of communication on a potential refinancing and / or liquidity event can be expected in June. The Germany-based Telco and broadband group says it expects a supportive lender group, adding that their shareholders are going to be a strong part of the story. 9fin’s Nathan Mitchell has been ahead and front of centre on this name for several months, and despite the positive noises from management, the same problems and uncertainties from before persist. With leverage at 7.6x (and rising) another significant injection from the sponsors (€550m already, including a €75m top up last November) is needed. 

But as one listener from the earnings call noted, usually when you appoint Perella Weinberg it's not to do a straightforward A&E or refinancing.

Another week of stressed earnings reports and transcripts, some doom scrolling on AI impacts on our lives/careers and US debt ceiling talks anxiety, with little time to get too cerebral. 

There was also some hasty catch-up on Succession episodes in order to be in-synch with the final episode on Monday night. The highlight was the nuts Kitchen scene between Roman, Shiv and Kendall, which makes more sense when you read that this was the final scene that the actors filmed. I won’t be losing readers by placing any more spoilers here, just this image.

There was also a lot of googling and reading of articles/tweets on Groupe Casino and EG Group. Luckily our machine learning and crawlers stopped this for EG (hat tip Owen Sanderson)

The WSJ found out what the record $237m whistleblower award from the SEC was for. It related to Ericsson. 

And finally, as is traditional, some football news. 

The season is over for Brighton and Hove Albion, with a sixth-placed finish and a place in the Europa League. There have been so many highs and a few lows this year. One of the best commentaries from our fantastic fan base, has been from Jonathan Bradshaw — better known as the Brighton Bard — who I had the (brief) pleasure of meeting on Wembley Way after we lost the FA Cup semi-final on penalties. 

There is a great piece in The Athletic with his poems throughout the year providing a prose diary of our amazing season. This is the one he penned after we secured European Football:

Weeping in front of a group of strangers,

Some just shook their head and looked away,

As no seagull has ever got to say the following before,

“WE’RE GOING ON A EUROPEAN TOUR!!!!!”

58-days to the start of the new season, and counting.

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