With one day to go, Bloomberg’s global bond aggregate had posted its best month since December 2008, and the US component the best since May 1985. 

As one commentator aptly put it, the recent sharp rally in bonds appears to be a “duration play for a soft-landing world”.

Markets are now pricing in 2024 rate cuts as early as March, and a full percentage point on both sides of the Atlantic by year-end. Risk asset spreads are at the tightest levels in over a year. Is it really just over two months ago we had the rates puke? 

Most forecasters agree interest policy rates have peaked but there is a huge difference in glide paths on growth (as the Economist shows below) and rates. Deutsche Bank is now the lone voice (among banks) for a US recession, calling for a hard landing in the second half. It cautions US HY leverage is as high as it has seen outside of a recession since 2005, with non-cyclicals particularly at risk.

BofA is another research house in the more bearish camp. It says don’t confuse the lagged impact of higher rates for no impact. But it then goes on to say the US HY market is of higher quality than historical levels, with most issuers having “levers to pull and glide their debt level to where they are comfortable with the new coupon”.

The bank’s analysts caution the residual (34% of US HY), and mostly private, issuers will face difficult decisions whether to cut deep into the businesses or deep into their debt. This is more prevalent in loans (73% private) and “completely dominates private credit”. It adds that net downgrades are likely to be around 5% with the triple-C bucket doubling in size in 2024. 

As a side-note on Private Credit, looking at Lincoln International’s EU insights Q3 report, while covenant defaults remain lowish for the private credit deals its advisors track at 3.9%, globally they saw 550 amendments since the start of 2023, which is around 15% of the private credit valuations they had performed. The cadence is increasing too, with 2021 vintages particularly prevalent. 

Deutsche analysts are defensive on HY returns, forecasting sharp widening of spreads in a no landing, and hard landing scenarios in both US and Europe, with limited room to tighten on a soft landing (not their base case, but seemingly base-case for everyone else):

In Europe, Deutsche forecasts a shallow recession in the first half of 2024, and credit spreads to be range-bound, before widening sharply as the US growth backdrop deteriorates in H2 24. 

“Tight spreads on the back of strong technicals, mounting maturity walls and the increasing pass through of higher interest rates warrant caution when it comes to HY-rated Non-Financial Seniors — more so in Bs than BBs.”

It is worth noting, despite the recent tightening in LevFin spreads, downgrades and defaults are already rising, particularly in the US, with corporate leverage elevated historically.

And while the US LevFin maturity wall in 2024 is largely dealt with, the proportion of the market due in two and three years is historically high, with 9.2% of the total coming due in next two years and 22.3% in three years. In Europe this is even higher at 12% and 30%, illustrated below:

The main reason is issuers remain reluctant to refinance at current yields, with hope implied that rates can fall sharply from here. Sub BB borrowers are particularly at risk if this fails to occur — great chart from Deutsche on expected rises in interest rate costs:

And as 9fin’s distressed and restructuring team is well aware there has been a pick-up in fallen angels (up €5bn since 2022 to €12bn) mostly coming from real estate. But this hasn’t affected wider EHY market dynamics given little net supply (save HY hybrids and bank senior paper) resulting in strong technicals for EHY spread compression (as fund redemptions wane). 

However, Deutsche notes there is €25bn of IG notional very close to being downgraded to HY (of which €9bn is real estate). The tailwinds are likely to be less strong in 2024:

Fallen angels were a growing area of focus for 9fin’s analysts in recent months, as we anticipated downgrades for a number of names whose debt is trading at stressed/distressed levels, such as Aroundtown, the German RE firm — see Emmet Mc Nally’s excellent series here.

Sending out a distress Signa(l) 

As I said in the Workout introduction, events can happen that are big enough to have seismic impacts. One such earthquake could be the messy collapse of Signa Holdings. 

Our colleagues at Bloomberg and the Financial Times clearly thought the implosion of Rene Benko’s real estate empire was a big deal. Most of their financial journalists chipped in, posting numerous daily updates after a number of Signa entities were forced to file for insolvency including Benko’s vehicle, Signa Holding on Wednesday.

Whether this is a Minsky moment for real estate is moot, but it has already created some shockwaves, with Julius Baer issuing a statement (on 27 November 2023) reviewing its private credit business, after detailing provisions of CHF 70m relating to a single large exposure in its private debt loan book of CHF 606m comprising three loans to different entities within a European conglomerate. 

“The aggregate exposure towards this client group is secured by multiple collateral packages related to commercial real estate and luxury retail and is now subject to a longer-term restructuring.”

Signa wasn’t specifically mentioned by the Swiss Private Bank, but handily JPMorgan analysts had published a note a fortnight ago mapping out the liabilities at Signa Prime and Signa Development and individual bank exposures for journos to get up to speed. 

As at FY22, Signa Prime Selection reported a gross asset value of €20.4bn and a balance sheet size of €17bn. The JPM report said it had €10.7bn total financial liabilities, including €6.7bn of total outstanding loans, €1.29bn of senior unsecured bonds and €1.34bn of hybrid capital instruments. Signa Development had €2.3bn of total financial liabilities, including €1.1bn of loans, €0.3bn of EHY senior bonds, and €0.4bn of hybrid capital.

Whether Signa Development will be next domino to fall is unclear, but its bonds are in single-digits. The 2026 SUNs were as high as 70 in late September, before coming under pressure in late October as the problems at Signa Holdings became apparent. They tanked around 17 points to 9.75-mid since Signa Prime filed, according to 9fin’s data. After Signa Holdings filed, the bonds were suspended from trading. Arini is a large holder of the notes, as reported.

The same day as Signa Holding filed, its peer Aroundtown was holding its Q3 23 earnings call. As Emmet McNally reported, management raised some warning signs about the increasing difficulty of accessing bank lending amid distress in the sector, alluding to the trouble facing the SIGNA complex without naming it directly (transcript and playback available here).

“The lending process is taking longer and is only further protracting or slowing down. Bank appetite for commercial property lending, especially some unnamed segments, has reduced and they are becoming more selective (note we raised this in our recent analysis).” 

The rhetoric from the Aroundtown C-suite was pretty strong, noted Emmet in his write-up:

“Management suggested there is a probability banks will become even more selective as loans mature and borrower solvency or their ability to maintain health equity cushions is further strained. They alluded to the SIGNA complex (more here), indirectly, and the impact of its recent bankruptcy filings at various levels.” 

Aroundtown indicated on the call that it will not be calling its hybrid perpetual notes at first opportunity in January as their reset rates “are not much different to current bank financing”.

And there is the rub — the rising cost and lower availability of senior secured financing. In our original analysis report in early November, Emmet called this the elephant in the room saying:

“That problem is that the cost of debt on the perpetuals tends to at least double when the coupon resets after first call. This strains the company’s cash generation and its interest coverage ratio. There is decent headroom on the latter, but there are close to €3.3bn of perpetual bonds facing first call between 2024 and 2026 at Aroundtown and GCP combined, and a doubling of the interest expense on that quantum of debt would certainly be felt in various ways.

There is no easy solution, admittedly. Raising fresh equity when the share price is so depressed does not serve equity interests and calling the perpetuals with cash would irk priority bondholders. The perpetuals cannot be refinanced with other perpetuals as the cost is too expensive and secured debt may cost close to the reset rates on the perpetuals, but secured debt has a fixed maturity, non-negotiable interest payments and potentially restrictive covenants, none of which the perpetuals have. Similarly, raising secured debt to refinance the perpetuals would prime SUN bondholders.”

Aroundtown does benefit from decent liquidity, its hybrids are rated investment grade, albeit only just (BBB- on negative outlook). S&P said in June there is a one-in-three chance of a downgrade in the next 12-24 months under its base case. Amazingly, after two other hybrids (totalling €1.1bn) were not called (going from zero to 50% debt treatment), they still assume the “other hybrid bonds with first call dates later in 2023 in 2024 would be replaced at materially higher coupons than current pricing”. I would gamble on those odds being a lot shorter after this week’s events. 

If the comments coming from panelists at a couple of restructuring lawyer events this week were anything to go by, the situation out there is even worse than real estate companies are reporting — I would caveat that restructuring event participants are like undertakers, always talking up their business prospects and waiting for bodies to arrive!

One believed German commercial real estate prices have fallen by 15-20% from the peak (officially the VDP Property Price Index showed a 10.3% YoY decline in Q3 23), but they could still fall by another 15%. Unlike the UK, in Germany many lending banks are smaller specialist property lenders, with a much bigger concentration of real estate debt versus balance sheet size. Another speaker noted the ECB is concerned enough about the situation to undertake some site inspections. Banks continue to cut lending volumes and will divert capital into problem assets and seek to prolongate loans, unable to take write-downs in a single year.

And the fear is Signa and other potential failures will result in yet more distressed assets coming onto the market. Many of these are development assets that will need new money and revised funding structures to get to completion. 

This should create plenty of opportunities for specialist and opportunist alternative investors. There is a need for junior and mezzanine financing to bridge the funding gaps, and they can name their price. For those who get it right, it could be a once in a decade opportunity. 

But my gut feel is it will take another one or two quarters before the full extent of the problem and the quantum of distress is known. We are still some way from the bottom. 

As the late Charlie Munger said: 

“You make your money by the waiting… It takes character to sit with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.”

Dare to Care

After covering a number of care home and hospital restructurings over the years — Four Seasons Healthcare, Southern Cross, HC One, Barchester, Care UK, Orpea —  I often wonder why they remain attractive to private equity sponsors. 

Especially given the amount of negative headlines from mainstream journalists about the evils of private equity ownership, simplistically thinking that sponsors are stripping out costs (mostly labour) and thereby reducing the quality of care to make excessive profits. 

The short answer is that the healthcare sector continues to outperform the broader market. According to a Bain Capital healthcare report, PE deals produced IRRs of 27% versus 21% for the industry average in 2021. Note a huge chunk was multiple expansion and I suspect a lot of the revenue growth was via roll-ups — not a phenomenon exclusive to healthcare, mind.

Looking into care homes in particular, PE firms own three out of the largest five UK firms, but that was just 12.6% of the total-for-profit beds according to LaingBuisson, so plenty of room for more consolidation. In the UK and many European countries there is steady income from governments and local authorities and supportive long-term demographics 

But before I sound like a marketing document for PE fund investment in care homes, the picture is different since the pandemic. Government support is less certain, costs have spiralled, big staff shortages (don’t mention the B word, but look at the UK net migration stats for clues) and labour costs are soaring due to rises in the minimum wage. In addition, there is policy inertia over what to do with social care, but conversely the sector can help relieve pressure on hospital beds. 

Many of these issues are also prevalent outside the UK. Last year brought the collapse of Europe’s largest care home operator, France’s Orpea, admittedly with a huge dollop of mismanagement, negative press and potential fraud. 

And Nordic Capital’s Alloheim is also struggling. 

The German care home operator, as 9fin’s Laura Thompson revealed this week has fully drawn its €100m RCF to meet interest payments and there is no sign of a refinancing plan despite going current next February. The loans languish in the low 80s.

Another care home business trading at distressed levels is Voyage Care, a name I was bearish on at issuance (5.875% in Feb 22), and which reported earlier this week. The February 2027 bonds are yielding a lofty 16.75% at a cash price of 73.81-mid. 

After taking a look at the presentation and the transcript for the UK-based group, I think it could be time to cover my hypothetical paper short, and maybe even go small long. 

Before you send the men in the white coats over to take me away, hear me out. 

Yes, Voyage Care been hurt by labour costs, with the UK minimum wage rise of 9.8% translating to around 7% more in costs. The company hopes to recoup this with record 8-9% fee hikes, adding that local authorities (LAs) are more open to inflation-related fee hikes. I would caution though that most LAs set their budgets in Q1 24. 

The firm’s agency staff reliance, however, is low — below 3%, and less than pre-Covid. 

Admittedly leverage is rising, but management says that the 7.6x seen in Q2 23 is the peak and that should fall to more historical levels (five and six handles) in upcoming quarters. They didn’t give specifics, but if price rises stick and poor March and June 2023 quarters drop out, leverage could be in the sixes by this time next year. 

Cash is low (in mid-teens) but is stable, and there is an undrawn £50m RCF to call upon. Sure, there is a springing covenant management said is based on a look-back basis and is triggered at £26.2m of adjusted EBITDA (currently £34m on an LTM basis). 

And if you believe management, the £260m of bond debt is easily covered by £320m of property value. The LTV is a high 81%, but this drops to 60% based on the market value of the debt.

The care homes haven’t been revalued for two years (at the time of the bond issue) and there are no plans to do so until the next refi. Management claimed the actual value should be higher if done now. One analyst on the call was trying to convince them to sell properties at a higher multiple as assisted living, but that idea didn’t appear to hold much sway with management. 

And CEO Andrew Cannon is leaving after eight years (once a successor is found), creating uncertainty at the top. He claims to have left the business in a good position, but I suspect some of the funds that bought the bonds in February 2022 might dispute that. 

Sponsor Wren House Infrastructure, which bought in during 2022, is said to be supportive. It doesn’t have experience in the sector, although to be fair many infra-focused funds have moved into sectors and businesses with ‘infra-like’ qualities. 

Asked on the earnings call whether the company could use the RCF (not super senior) to repurchase bonds at a discount, management said that would be up to the sponsor to decide. 

Even despite recent multiple compression, I would say care home businesses could still fetch 8-9x, and there is a decent margin of safety based on the property valuation. 

So, this might not be a bad entry point. I would caveat that we haven’t done a full analysis. 

Dare to Care?

In (very) brief

Given that its closing on the witching hour, as I’m writing this, and well over my suggested word count, I will keep this section even briefer than usual. There were some big 9fin content and company updates, so I would highly recommend you click through for more info. 

ATOS, the troubled French IT services behemoth finally admitted this week that its demerger and capital increase plans were in trouble and was seeking to amend a deal with Daniel Kretinsky. To understand more, read Denitsa Stoyanova’s two-part series — Atos to split or twist?

Talk Talk has given a update on the sale of an equity stake in its wholesale network business. 9fin’s Nathan Mitchell estimates a sponsor equity injection of over £500m will still be needed. 

Graanul has given more details on the dispute with its key customer which cost it ‘tens of millions of EBITDA’ in 2023. The contract has been revised, but market conditions still remain challenging. It claimed that the distress of its competitor Enviva, is unlikely to lead to price cutting. 

Adler Group has said that the German RE market in Q3 was adverse than expected, with the direction of travel in Q4 was similar, albeit at a slower pace. It expects a further devaluation in the low-to-mid single digits when the next revaluation occurs in Q4 2023, after booking a 8.4% negative adjustment in the first half on the value of its yielding and development assets. 

What we are reading/watching this week

There was a wave of stressed/distressed company earnings this week, many of which we are still wading through, so little time for much reading of more cerebral content. As flagged, I spent a lot of time reading through CPI Property financials last weekend, in preparation for an analysis of the allegations from short seller Muddy Waters. The company released its Q3 numbers late last night, and said it will fully respond to the points next week. 

But it did take a swipe at the short-seller, calling it a “flashy, engaging, but erroneous report specifically designed to discredit CPIPG’s reputation and disrupt the Group’s efforts to support our investment-grade credit ratings”.

On its founder Radovan Vitek, it said: “CPIPG is a proud family-owned company and never obscured our relationship with Radovan Vítek or his family. Disclosures on share buybacks, shareholder loans and related party transactions are extensive and easy to find. On principle, Radovan Vítek cannot ‘cream’, ‘squeeze’ or ‘brazenly loot’ his family company, as alleged by Muddy Waters.”

It also said: “CPIPG continues to explore equity and capital raising in multiple forms. Our shareholder, Radovan Vitek, is considering a meaningful contribution of assets and/or cash before year-end 2023.” So even if he has brazenly looted, he may be repaying some of it.

The death of Charlie Munger has many of us going back through his quotes, I particularly like:

“Every time you hear EBITDA, just substitute it with bullshit”. 

On the same subject, my favourite meme this week:

Despite a growing injury list its been a great week for Brighton (12 unavailable), with a nervy 3-2 away win at Nottingham Forest with captain Dunky sent off for calling the referee a ‘bald pr**ck’ — a statement most football fans would concur is accurate, after a series of blunders.

And a 1-0 away win in Athens last night secured our progression to the knockout stage of the Europa League. Not much time to recover, with nine games in December — Chelsea is next up.