But in the past week, some doubts and cracks have appeared for the soft landing scenario and the benign long term outlook for rates and inflation. 

Goldilocks, remember, is a fairy tale.

First we saw Moody’s downgrade a raft of US mid-sized bank lenders, 10 in total, and put another six on watch. Then we had the surprise windfall tax imposed on Italian banks, spooking wider European markets. This was closely followed by Chinese consumer prices turning negative as domestic demand collapses, prompting calls for fresh stimulus. Perversely (if you think China is still the swing factor for world demand) commodity prices showed signs of life, with sharp rises in natural gas prices (after Australian strikes) and soft commodities such as rice and wheat.

Source: Financial Times

And while headline inflation continues to fall, core inflation and rate expectations are proving more stubborn. Inflation-adjusted yield expectations five years out are at levels not seen since before the financial crisis, at around 2% in the US.

And 2.5% in the Eurozone, a good summary here posted yesterday (10 August) from ING

Last night’s 30-year auction in the US showed how difficult it could be for markets to absorb additional debt supply. It issued $23bn at 4.189% (closed at 4.25%) with primary dealers and the Fed (40% of the auction) taking most of the supply — I thought QE had ended!

Higher rates (nominal and real rates) are likely to have a big impact on consumer activity and also on businesses, from an affordability and availability perspective. US Consumer Credit Card debt this week topped $1trn for the first time (it was $770bn two years ago) with an average 20% repayment rate, and US 30-year mortgages now cost a whopping 7.4% (versus 5% in Aug 2022 and 2.8% in Aug 2021).

Apollo Global Management is worried, saying a new default cycle has started and that “markets are not taking the ongoing rise in defaults seriously” (the firm’s bolding for emphasis), adding: 

“The reality is that more and more companies are defaulting because the cost of capital is higher, and Fed Chair Powell says that interest rates will stay at these levels ‘for a couple of years’ so tight monetary policy will continue to have a greater negative effect on the economy and capital markets.”

Apollo looks ahead for potential wake up calls:

“What could be the aha moment in markets? Once there is a default by some household name in credit, we will likely see an overnight change in market sentiment from bullish to bearish.” 

I’m not sure if that would be WeWork, perhaps AMC, or another Meme Stonk?

For those keen on scary charts — or should that be axis of evil? — Apollo has a full deck here.

The availability and cost of bank finance is deteriorating much faster than many think. The closely watched Fed SLOOS report shows how much US banks are tightening their loan criteria. 

"The most cited reasons for expecting to tighten lending standards were a less favorable or more uncertain economic outlook, an expected deterioration in collateral values, and an expected deterioration in credit quality of CRE [commercial real estate] and other loans," the Fed said.

It is worth noting that US regional and mid-sized banks are much more exposed to CRE (arguably the canary in the coal mine) than at the time of the GFC.

Source S&P Global, Apollo

One of the best ways to assess the performance of larger CRE loans is to look at CMBS delinquencies, which are rising sharply according to Trepp, up 338bps since last December to 4.41% in July.

Source: Trepp

So why should we be so concerned about real estate? 

Well, globally it accounts for around 10% of the $9trn of assets under management from private markets (source Morgan Stanley), of which the US accounts for 55%, Europe 30%, and ROW 15%

CRE has been at the forefront of most debt default cycles, notably in 2007/2008, and CRE arguably brought down RBS, leaving British taxpayers to bail it out with a £45bn equity injection. 

The good news is that large banks have much less exposure to CRE than at the time of the GFC, according to Morgan Stanley, which eases systemic risk. MS analysts produced an excellent report this week, called Sizing the CRE lending Risk, on bank exposures and their resilience, which draws in analysis from a number of their research teams. 

10 years ago, eurozone banks financed 90-95% of all CRE exposures, around 10% of their total loan books, notes MS. This has reduced to around two-thirds, and 5%. But there is a decent dispersion, with German/Austrian banks most exposed at 15-20% versus France/Spain lowest at 6-7% of their loan book. Exposure for the unlisted sector and smaller banks is higher at around 11%. 

The bad news is that a fair chunk of this debt is coming due by the end of 2025, which is before any expected recovery, and the cost of debt for real estate companies is set to soar.

Source: Morgan Stanley

MS believes the rises in cap rates and fall in real estate valuations has a lot further to go. An exception is the UK, whose sell-off has been well ahead of its peers, with London offices already down 20% from their peak. MS expects eurozone office prices to fall by around 20-25% cumulatively by end 2024, retail by -10%, logistics by -9% and German residential by -15%. 

Prices have currently fallen in US and Eurozone by 5-10%, but transactions are so few, and bid/offers so wide, that a fair amount of price discovery is still needed. Banks have been slow to provision thus far, despite 55% of their loans coming due in the next five years, notes MS. 

But this will have to change. With average LTVs in Europe of around 55%, a 20% slump in collateral values would lift LTVs to c. 69%. With banks unlikely to raise senior LTVs for lending (also worth noting many EHY RE bond covenants are set at 60-70%) there is a big gap for mezzanine and/or equity to plug in order to get a refinancing over the line. 

In addition, there is heavy investment required to meet more stringent energy standards, which the European Commission estimates to be around €275bn (not a typo) per year for the industry. 

And while the listed property sector has termed out their debt “relatively well”, for private real estate markets, the picture is less rosy, say MS property analysts:

“We appreciate that in private real estate markets financing may well be shorter, leverage can be (materially) higher and asset quality is more varied with a lower percentage of privately owned assets with green certification. But listed markets represent a small fraction of the overall asset class. We expect more and earlier pressure points coming from private real estate markets.”

We’ve already seen this from German Real Estate EHY borrowers, and selected Scandinavian names such as SBB and Heimstaden (reporting next week, btw, here is their take in June on the European resi market). While European CMBS is now much smaller than its US cousin, we would expect more defaults there too, and my new structured finance colleagues will no doubt report on these in the coming weeks. Owen Sanderson has a taster in this week’s Excess Spread with Taurus 2018-2 UK, whose anchor tenant is WeWork, also 9fin’s landlord. 

Let’s hope the free coffee and beer stay if, as feared, WeWork files for Chapter 11 soon. 

Levers to Deleverage

Last week we pointed out that leverage for European LevFin borrowers is flatlining and interest cover declining, reducing the options for borrowers looking to deal with their 2025/26 maturities. It’s most notable for bond issuers, as loan-only borrowers have had a much easier ride with their A&Es. 

Some stressed bond names such as ams Osram and Pro-Gest are exploring non-core divestments, asset sales and operational cost improvement plans before approaching markets. Look out for a deal prediction on ams soon. 

Better recent performers such as CVC with Douglas, and Bain/Cinven with Stada, are reportedly looking at the possibility of IPOs or sales, presumably leaving new owners to deal with their maturities. Our change of control analysis on Stada is here. Douglas has portability at 4.75x (its heavily adjusted reported leverage was 4.9x in March 23, from 6.0x a year earlier). 

But IPO and merger activity remains subdued, as multiples compress and cost of funding rises. Sponsors might need to get more creative, or put their hands into their pockets and pull out some of that famous dry powder, if the left pocket, right pocket trade from fund-to-fund transfers isn’t available.

Loose docs can also provide an option to extract value, and/or provide security for fresh financing, such as under the Lycra variant, or perhaps we will see more coercive exchange requests.

Hat tip to our CEO Steven Hunter, who spotted an intriguing Engineering Group press release which is reproduced below.

Does that mean they are contemplating some form of drop down transaction? 

Which leads us to the main event of this week, and the stolen subhead (with permission) from 9fin’s Nathan Mitchell’s write-up on the Altice France Q2 23 conference call. It included a special guest appearance from founder Patrick Drahi who sought to reassure investors over the impacts of the corruption scandal, and other assurances that the business plan is on track, after a couple of poor quarters. 

Drahi said that deleveraging was the number one focus, targeting one turn of leverage reduction over the next 12-months, adding he was super confident of achieving this target. There were a number of potential levers outlined to achieve this, including asset sales, strategic equity options, discounted debt purchases, group consolidation and shareholder equity. 

The sale of the French data centres is well advanced and is expected to net €800m to €1bn. An unsolicited approach for its media business for a similar amount was quickly rebuffed, with the company valuing it nearer to €2bn, but it added it was open to further discussions. 

If both are completed, this should be enough to handle €1.6bn equivalent of 2025 maturities (our interpretation of the debt documents is that they cannot buy back debt below par, but it can repay the 2025 SSNs without having to repay other secured debt pro rata. This interpretation is subject to covenants under the SFA). Deleveraging further to deal with its bloated capital structure, in particular the €1.3bn-equivalent 2026 TLBs, is unlikely without pulling further levers. 

This could involve some form of contribution from XpFibre, which sits in an unrestricted subsidiary and is expected to generate €600m of EBITDA in the mid-term (which we interpret is later than 2026). But contributing it now would be re-leveraging, as it is 8.3x levered and with further capex spend in 2024 required for its build out. It won’t become a cash cow until 2025, at which point Altice projects that 90% of its EBITDA will flow through to FCF. Therefore, XpFibre is unlikely to be contributed until 2025 and potentially beyond. Judging from the Q&A session, many analysts are much less optimistic on the projections than management. 

Whatever your view on XpFibre and whether it can drive the turnaround, TLB holders extracted big concessions on their A&E, as under new covenants XpFibre asset sale proceeds including the shares must to be applied to deleverage, unless net secured leverage is less than 3.5x. 

We think the two potential asset sales might deleverage by around half a turn, so the remainder will partly depend on discounted purchases of debt — you get more bang for the buck with the SUNs, which are trading in the 30s and 40s. But this is unlikely to impress the senior secureds, and SSNL won’t reduce, so doesn’t provide much benefit for a refi of the SSNs/TLBs. 

Cash generation isn’t great (especially if you exclude the benefits from crystalising swap agreements), so Altice France might need to use its chunky €1.025bn RCF to make discounted debt purchases. But L2QA leverage is very close to the 5.25x test on the springing covenant, which would reduce RCF utilisation to just 40%. 

This leaves an equity injection from Drahi to take some of the strain. 

Most of his personal wealth is tied up in Altice France, but the other options could be to monetise some of his 25% stake in BT, or potentially sell the Dominican, Israeli, or Portuguese business in Altice International, if he is able to upstream some of the proceeds via dividends. 

Perhaps the equity isn’t really equity after all. As Nathan outlines:

“When quizzed on what the equity levers entail, Drahi suggested that once assets have been sold, inside and outside of France, the company can use this money to buy back the debt. If the proceeds come into the group in the form of an equity injection, then Altice France is likely able to use the cash however management desires.”

In brief

Solvay demerges: We have had a few enquires of late on Solvay’s demerger plans. A crossover French chemicals credit, the plans have created a potential trading opportunity for holders of its 2029 bonds, after the recent launch of a liability management exercise. At question is the cessation of all or substantially all of the business, which could potentially lead to an event of default, if it exercises its SpecialityCo spin off, and a repayment at par plus accrued. The 2029 bonds have rallied over 10 points to 95, in recent days, with Houlihan Lokey representing a group of noteholders. 

SBB restates: Chapeau to our friends at the FT for spotting that SBB had published its Q2 22 results twice, with the second showing that short-term debt was SEK 3.2bn higher ($300m) than originally presented, with long term debt adjusted lower. The Swedish property company finally admitted the change a few days later, claiming it was down to an ‘editing error.’

Takko completes: Four months after agreeing to hand over the keys to its bondholders, Takko’s restructuring completed yesterday. The German discount retailer will be controlled by a group owned by AlbaCore, Napier Park and Silver Point. For the full terms and an overview of the restructuring, our QuickTake is available here.

What we are reading, watching, this week

Commentators are starting to recognise the stark similarities between what happened to Japan in the 90s and 00s and what is now developing in China. 

Could the World’s second largest economy be suffering from deflation, not inflation, and stagnation and not stagflation? The best recent commentaries on this are the South China Morning Post’s three-part series and Can China escape Deflation, from the Economist. 

As the prices of offices tumble, and companies wrestle with the future of work and how to entice their employees back into their headquarters, I love the irony, that Zoom wants its workers to return to the office!

Talking of offices, remember community adjusted EBITDA at WeWork? I suspect they would like to revive the concept, given their latest woes, with the latest board appointments reading like a who’s who of restructuring professionals. It’s time to revisit the Forbes piece from 2019 — Why WeWork Won’t Work —trashing its business model. 

Africa has seen its first debt-for-nature swap, with Gabon buying back $500m of foreign bonds in return for a 15-year ‘blue bond’ at US Treasuries plus 200bps. The tight pricing was obtained via a political risk insurance policy from US International Development Finance Corp. For a cracking assessment of the transaction, IFR’s write-up is the place to go.

The Gabon bonds are probably a better investment than Tingo Group Inc, firmly in the sights of Hindenberg Research whose report Fake Farmers, Phones and Financials — The Nigerian Empire that isn’t — was released in April. The follow-up letter to the board with 38 questions is remarkable, for a taster, a snapshot of questions 22-26 is shown below

Strong competition for headline of the week, after 9fin’s David Brooke’s “Lend it like Beckham” on private credit and football finance, we have this genius effort from the FT: Icahn seen clearly now the gains have gone — the dividend was finally cut, after year’s of poor performance. 

Sticking with the FT, I often wonder if they have lost touch with their core readership. It was difficult to tell if their Yacht Desking piece was tongue in cheek or not, as they recommended a $55k self-righting Bugatti pool table! 

And with Premier League football back on our screens tonight, who would have thought that a Brighton player would break the English transfer record at £110m?

It was only on 14 January 2023 that we beat Liverpool 3-0 (the scoreline didn’t flatter us) with Moises Caicedo starring — I gave one journalist ‘Moises parts the Red Sea’ headline for free. 

A reminder of how far we’ve come from the WeAreBrighton website, commenting on a game between us and Luton Town (our opponents on Saturday) at the Withdean Athletic Stadium in March 2006:

“As the rain tumbled relentlessly onto the heads of the 7,139 brave/loyal/insane fans who had turned out to watch a Brighton side seven points adrift of safety in the Championship and without a win in 11 matches, so it turned the pitch into a swamp more reminiscent of the Everglades National Park than the Withdean Woods Local Nature Reserve.

Whilst Florida has alligators lurking in its murky waters, Brighton had Richard Carpenter. As a tough-tackling midfielder, Chippy loved nothing more than a slide tackle and needless to say, he was in his element aquaplaning through the mud as the conditions became increasingly farcical the longer the game went on….

The one overriding image seen through the Withdean rain is Carpenter taking off and sliding a full 25 yards on his arse to dispossess a Luton player. It was such a ridiculous challenge that it drew louder cheers from around the ground than Noel-Williams’ goal.”