Friday Workout — Is LevFin broken; MetalCorp solid

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Friday Workout — Is LevFin broken; MetalCorp solid

Chris Haffenden's avatar
  1. Chris Haffenden
16 min read

Will the markets ever learn? Is bad economic news ever good news for risk assets, and why is everyone every month or so desperate to find reasons for a rates pivot, given it has been the worst investing strategy of 2022?

In July, with most of the world heading into recession surely central banks would now temper their rates rises. No, if anything, listening to this narrative and concerned about markets’ reaction central bankers doubled down on their hawkish statements. Last week, combined with dubious fiscal policies from the UK, we reached peak bearishness with feverish talk about fiscal debt sustainability amid doubts over the robustness of markets and financial institutions.

Over the weekend, speculation was rife about potential casualties from whipsawing bond yields, which led to sell-offs in risk assets back to prior lows amid yet greater fixed income volatility. Credit Suisse was in speculators crosshairs, with its CEO reassuring staff and markets about its solvency too strenuously for some FinTwits who claimed to see fire as well as smoke. LinkedIn was full of posts from the restructuring community licking their lips and forecasting the biggest wave of deals since the GFC.

In light of the above, the sharp relief rally on Monday/Tuesday was impressive. It was part inspired by the Twitter bid revived by Elon Musk, leading to our US team running the numbers on the likely size of the underwriting bank losses. Some thought we were too low at half-a-bill.

As well as a rally in Twitter stock, the risk asset recovery was driven by talk that central banks will pivot if casualties emerge from the dislocation caused by rising rates and extreme bond volatility. Bad news is good news again.

But aside from pension funds, do we really know who else is at risk here and where the true leverage and exposure lies, is it a solvency or liquidity crisis, or neither?

Fantastic Beasts

In Europe this week, some rare beasts were sighted — previously presumed to be on the verge of extinction — two new EHY primary bond issues were spotted emerging from the gloom.

Market darling, Sweden’s Verisure with alarms but no surprises; and the much less fashionable Tendam the Spanish retailer — renamed from Cortefiel to distance itself from its past fashion mistakes — their braveness led to other beaten-up retailers such as Douglas to catch a bid.

Chunky price discounts were on offer for both.

The former priced at 9.25% and par (refinances a 3.5% bond) and right in the sweet spot for special sits funds, and the latter at lofty E+750 bps and 93. A big chunk of the orders, however, were from those rolling over their exposure, you are certainly paid to do so.

But while some borrowers can pay up to clear their 2023 and 2024 maturities, for other names it remains tough going, even if they can afford the huge bumps in interest cost.

Witness the difficulties with the House of HR bond and loan syndication. As my colleagues Michal Skypala and Laura Thompson outlined, just 60% of the TLB was covered despite a two point reduction in the OID, around half of the second lien was covered (mostly by special sits funds) with the bonds finally placed on hold four business days after the loan portion priced.

We still await a formal announcement on the 2L pricing – it has been eight days and counting.

Is LevFin broken?

This means that around €1bn of the House of HR underwriting remains on the banks book.

It was clear to us the bond sale was in trouble, by Friday lunchtime there was still no price talk or even price whispers. If you had listened to our US podcast a day earlier, you wouldn’t have been surprised.

More broadly, lead managers are going into radio silence mode, as an ex-colleague [with a loans banker wife] once said, some deals are designated DNR — do not resuscitate — in a coma but with no one willing to declare them dead.

Trying to establish the amount of debt that is still hung or yet to come to market is becoming increasingly difficult for our analyst and journalist teams.

How much has gone to private credit or as a private placement, re-cut as additional TLB, or designated and held by the banks as a TLA?

What is the length of the bridge, the likely cap rates, dates when reporting periods go stale? Are there any most favoured nation provisions to protect against further cheaper sales? (For a good primer on MFNs, see our 9fin Educational here). Have banks agreed to lock-up their holds?

LevFin’s not dead, LevFin’s resting. Just stunned and pining for ZIRP

Our loans team is working on a tracker to see changes to deal structures, to pricing, outlining leftover bridges, TLAs, lock-up periods and MFNs.

We are aware that some more transactions are due to launch soon, still willing to brave tricky market conditions. But many are already part backstopped with the arrangers hoping to sell at higher prices in the syndicated market and banks with lined-up alternatives for the rump.

Investors are getting savvy, however. We know of investors placing House of HR orders subject to the book being fully covered. Some complain OIDs are at least two-to-three points higher than where private credit funds are getting filled for deals. No wonder MFNs are back in vogue.

But natural demand is low, as the CLO arbitrage is so poor. As Owen Sanderson says in Excess Spread, over the past week it got yet worse. LDI funds are selling liquid assets, driving ABS spreads wider and “Senior CLO spreads suffered heavily from last week’s forced selling — around 37% of line items last week were CLOs, mostly triple A and double A paper. On Monday Prytania Solutions put triple A 60 bps wider on the week, and double A 99 bps. A trader described the senior market as “wholly dislocated and incredibly cheap.”

He adds “Loans were not in the immediate firing line for last week’s LDI-driven sell-off — trading loans is a poor way to raise cash for a margin call, because the settlement times are too long…but if the LDI funds are still pushing on to raise more cash, there’s a decent chance that some of these could put further pressure on pricing.”

Staying Liquid

This dynamic isn’t helped by appalling liquidity in the secondary market. Investors have regularly complained to our editorial team that it can be virtually impossible to transact clips of over 5m and even if they can, it is well outside the stated bid/offer spreads by dealers.

So, it was of great interest when a €270m BWIC arrived earlier this week, with bids due yesterday afternoon. The portfolio included a number of stressed names including Biscuit International, Rohm, Flaxt Group, Cerelia and a number of names from the Ion complex. Covers were not available at time of publication. We are reliably told this is from a called CLO and not a LDI driven unwind.

So how can we fix the broken mountain of debt and boost market liquidity?

One idea is to go back to the future and for regulators to allow banks to hold more risk, which provides more market depth and helps avoid flash crashes with no-one able to take the other side. Having a healthier secondary will encourage switching, remove market anomalies and result in more efficient markets and participants have more confidence in execution.

Does the originate to distribute model need fundamental change, and/or can lead managers do more?

Investors could demand that banks provide liquidity in names they issue, as this would encourage confidence in secondary. I remember in the old days of EM primary; some banks looked at the P&L holistically over the life of the deal and were prepared to subsidise market market making with some of their deal fees to maintain relationships with investors. Allowing desks to have back books and proprietary desk operations also allowed them to take advantage of market dislocations and boosted overall market liquidity.

Lead managers should also allow a proportion of their deals to go into less safe hands. This helps dealers provide secondary liquidity as they can find flippers to satisfy long-only orders.

This phenomena is not just limited to HY and Leveraged Loans, mainstream government bond markets’ liquidity has dropped alarmingly of late. The crowding out effect from central banks is one reason, another is the inability of banks to take proprietary positions or to fund purchases efficiently and cheaply.

It is worth remembering that QT has barely started yet, markets still need to find a normalised level for rates. Even if we don’t get another LDI event, there are plenty of other triggers — such as Central Banks selling Treasuries to support their currencies against the rampant dollar.

The buyers may be on strike longer than the railway workers. I remember the Plaza accord to deal with the strong dollar, is it time for Plaza II?

Metalcorp Solid?

In recent weeks, I’ve been surprised by the number of sharp movers on specific news events.

A good example is Ceconomy, the German electricals retailer dropped over 15 points on a two-notch downgrade to Ba3 and their CFO loss. Admittedly cash burn and consumer spending are worrysome, but on an initial skim, it feels overdone.

But every now and again, we get a proper tape bomb surprise, such as Saipem earlier this year.

Metalcorp falls into this camp. Its seemingly solid business came into question when it failed to repay the €70m left on its 2022 bonds on 3 October. Over the next two days, their 2026 bonds fell from 80 to 35.

The Luxembourg-headquartered metals and minerals group had intended to repay the €70m outstanding under the bond with €30m of its own cash, €30m from a planned term loan and €15m from monetising Guinean bauxite sales through letters of credit or stock finance.

However, the expected financier of the term loan “reneged” on the deal which was attributed to significant financial market turbulence.

This strong wording intrigued me, not withdrew, but reneged, and presumably at the last minute. I assume this wasn’t a triggering of a material adverse change or force majeure — as this is a very high bar to prove as a number of court cases have shown — but it is indicative of the lack of appetite from banks in the current environment and tightening of conditions.

But is was only €30m to find, surely there must be other facilities it could tap?

Trade finance was the obvious option, but they couldn’t draw the commitments in time due to delays in shipments from Guinea to Chinese buyers. Compounding the difficulties in financing are sanctions against Guinea.

But as 9fin’s new hire David Orbay-Graves reported, management yesterday told investors that these sanctions have not resulted in assets and cash being frozen in Guinea. Once deliveries start, the risk shifts from country to counterparty risk.

The Q&A session focused on receivables lines, unencumbered receivables, and inventories, which management stated were €55m, with 20-30% of unencumbered inventory in Guinea.

There were also questions why the shareholder — Monaco Resources Group (MRG) hadn’t stepped in. Apparently MRG were caught completely unaware and will part of the solution.

Not a great time for the parent as it is also the owner of R-LOGITECH (R-L), a port terminals operator which issued a 10.25% 2027 bond just last month. It was shaken by the events at Metalcorp with R-L’s 2027 bond dropping from 89-mid to 70 on Tuesday, before recovering to 80. As reported, some R-L holders are wondering if MRG knew about troubles at Metalcorp when on the road for their bond issue.

During the presentation, management said that their preferred option is to to secure financing asap to repay the notes, according to an investor presentation. The financing will be “supported” by Metalcorp’s first delivery of bauxite from Guinea, scheduled for November.

Metalcorp said it is in discussions to hire a financial advisor to assist it secure the additional financing. The company is advised by law firm Norton Rose Fulbright.

2022 SUNs holders are being asked to defer the maturity by up to one year, retaining an early repayment option, in exchange for a coupon increase to 8.5%. The bond interest due on 2 October was paid.

The company is also set to ask holders of its €250m 8.5% 2026 senior secured notes (SSNs) for a waiver to avoid cross default on the SSNs should the SUNs not grant the maturity extension before defaulting.

Management confirmed during yesterday’s presentation that the bond changes must be approved by 75% of bondholders voting at any meeting, with a quorum of 50% of principal at the first meeting, falling to 25% of principal at any adjourned meeting.

Asked if the company expected the vote to pass at the first bondholder meeting, management said the quorum will likely not be reached in the first meeting, and it is likely the company will have to hold a second bondholder meeting.

Metalcorp published the invitation to bondholders to vote on the proposed changes today in the official German Gazette and on its website. The vote is on 22-25 October. It doesn’t leave a lot of time to avoid a default, as the 30-day grace period expires at the start of November.

It also means that special sits funds have less than a couple of weeks to get up to speed if they want to participate. It is certainly one of the most interesting sits we’ve seen this year.

Call of Duties for Directors

I was primed to look out the Sequana UK Supreme Court judgment on Wednesday by a number of lawyers, but due to workload was unable to attend, and still need to go through the full ruling. But luckily, a few law firms have already published their main takeaways on the key ruling on directors duties with some opining briefly on source calls yesterday.

The background is that the company paid a dividend to its parent when it had ceased to trade, with its sole liability an indemnity relating to US river pollution. Over 10-years later it entered into insolvent administration with its creditors saying the provision in the accounts for the indemnity was inadequate. They challenged the dividend saying it was a breach of duty as the directors should have had regards to the interests of creditors at the time and the dividend payment was a transaction at an undervalue.

There has long been a debate around directors’ duties when a company enters distress. Often creditors will fire off legal letters if they feel that directors are not considering their responsibilities to them, especially if the equity is underwater.

Despite the factual matrix of this case being far removed from many restructurings, the opinion of UK’s highest court was sought for reasons well beyond Sequana.

So what was the existing legal position?

Under the 2006 companies act directors have a statutory duty to consider what is most likely to promote the success of the company for the benefit of its members as a whole. But it is subject to any rule of law requiring directors to consider or act in the interests of creditors of the company.

The courts have over the past 40-years considered that directors should take into account interests of creditors in the “zone of insolvency.”

The issue came up in Virgin Active’s restructuring plan last year, and the ruling was surprising to many lawyers in its interpretation of management’s duties to consider alternative options from certain creditors. But while some involved were still spitting feathers weeks later, it was never challenged.

The Sequana judgment is “of considerable practical importance’” says Kirkland & Ellis.

K&E Partner Kate Stephenson summarised the TLDR in a LinkedIn post:

Directors of English companies must have regard to creditors’ interests from the point at which the company is “bordering on insolvency” or an insolvent liquidation or administration is probable; a real risk of insolvency does not trigger this duty.

This is a “sliding scale” and in many cases directors of stressed/distressed companies will have to balance the potentially-competing interests of both shareholders and creditors - but where insolvency is inevitable, creditors’ interests become paramount.

Creditors’ interests for these purposes are the interests of creditors as a general body

Once the “creditor duty” has been triggered, shareholders cannot authorise or ratify a transaction in breach of that duty.

The full K&E client note is here.

Budget Flip Flops

Our latest Top of the Flops was released earlier this week. It illustrates the damage created by the Kami-Kawsi mission on 23 September. An incredible 171 bonds from 93 EHY issuers fell by more than 5% in the week following the mini budget statement from the UK Chancellor.

Admittedly, we saw sharp moves in government bond yields, but if you look for spread to worst moves of 100 bps or more, it still resulted in 96 bonds from 56 companies.

If you filter the results by instrument currency, 32 sterling bonds from 19 borrowers saw price moves of more than 5% in the week following the mini statement. Debt collectors, retail, pubs, and gyms feature heavily, as does Together  the secured loans provider and largest mover during the week. Duration can have a big effect, however. For example, Virgin Media 2030 SSNs fell 5.2%, but on a spread basis they are just 12.4 bps wider.

Filtering for UK borrowers 43 bonds from 24 companies moved by more than 5%.

Moving onto loans, in theory they are more resilient to government bond yields given their floating rate nature, but we still saw 26 loans falling by more than 5%.

Once again GenesisCare was the worst performer, now in the high 30s. Some big moves too for Cineworld, Asda, Upfield, Kloeckner Pentaplast, Arxada and Prosol. However, just seven were UK borrowers and just one was denominated in pounds.

Giving an idea of general market weakness, with new issue demand thin, a whopping 319 loans (out of 1,229 in our universe) saw their prices fall by more than 2% in the past week.

Looking over a longer time horizon, 256 bonds from 160 issuers are now stressed/distressed (over 800 bps STW) — a sharp jump from a month earlier — 60 more bonds from 28 additional issuers. However, it remains below this year’s peak at end-June where we had 302 bonds from 188 issuers.

Unsurprisingly the biggest movers on a spread basis were short-dated bonds due in 2024 and 2025 as refinancing risks rise yet again, with UK names and those affected by drops in consumer discretionary spending among the worst hit.

New entrants into stress include Intrum (see our recent piece here), Ontex, David Lloyd, Polynt and giant auto supplier MAHLE which posted a shocking second quarter.

The number of loans trading below 92 (our measure of stress/distressed) has more than doubled to 356 loans from 160. Contrary to bonds this is now the largest number at any point this year (hit 293 in late June). 

The biggest loan movers in September were Veritas (also a big mover from the month before), Constellation Automotive Group (poor Q2 no.’s), Cineworld (filed for Chapter 11) and the friendless GenesisCare which is now in the 30s, with lenders reportedly hiring advisors.

Next week, look out for the second edition of Watching the Defectives, and some exciting news on how to find our restructuring content and the deals we are tracking.

What we are reading this week

I spent a fair amount of time earlier this week thinking more about the impacts of the events of the past fortnight and reading some of the post mortems — this one from Adam Tooze is probably the best.

The lady was for U-turning on Monday, and markets were more stable this week, but as mentioned earlier the selling of assets for LDI purposes is still ongoing and risk premia for sterling assets may have to rise further, on a currency swap basis, there is virtually none.

The FT revealed that investors are selling stakes in buyout funds at a record pace.

BofA’s European Credit Strategist says that markets will be more sensitive to debt levels and debt sustainability. Corporate bonds from high debt economies will be more volatile than those from lower-debt economies. Corporate refinancing costs are at record highs but EHY is still at record levels of compression versus IG at 2.8x. For comparison, when spreads were at these levels during Covid it was 4x.

For many observers, the next shoe to drop is real estate.

With mortgage rates now coming in at around 6x, simple maths on mortgage payments and affordability suggest drops of at least 20%, music to the ears of this cash buyer. Oxford Economics says at these levels house prices are at least 30% overvalued.

Commercial Real Estate is approaching a crunch point too. In this Bloomberg article by Jack Sidders, Hans Vrensen head of research and strategy at AEW, highlights a €24bn refinancing gap over the next three years on borrowings against UK, German and French real estate. MSCI suggests that looking at the top 10 tenants is not giving the full picture on default risk.

As 9fin gets ready to its move to larger office premises at end October and more staff coming in, there was an interesting report by the Economist about digitisation and new ways of working post-Covid. Working more effectively was meant to unleash stronger productivity, but the data doesn’t back up this assumption.

Crypto has arguably been the most stable and boring asset class in the past quarter, as prices bump along the bottom. But the insolvency processes of platforms are getting interesting, notes our friends at Petition — The Crypto Winter is Just Getting Warmed Up.

Sometimes less is more. This is the shortest speech by a finance minister, perhaps KK could learn something?

Brighton’s new manager Roberto De Zerbi had a great start at Anfield, 2-0 up after 20 mins and eventually drawing 3-3. His first touch isn’t bad either.

Three Hat Tricks in my Premier League fantasy team — but why did I change Haaland as Capt?

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