As an avid acolyte of the distressed market, I’m always looking for new restructuring techniques and following the evolution of insolvency processes. I’ve had the pleasure of being educated and mentored by some of the brightest minds in the industry within the past 19 years. 

Covering and living through some of the most high profile restructurings during this timespan has helped me to identify some of the red flags and develop a spidey sense of which deals are likely to get into trouble, sometimes as early as at issue — such as Ideal Standard. 

Carson Block from Muddy Waters took part in an excellent Cloud 9fin podcast this week with my colleague Will Caiger-Smith and he highlighted complexity — either in group structure, financing and/or in their financial reporting — as a potential red flag. 

You have to ask yourself the simple question, why is all this complexity needed. Is it necessary? 

Are management deliberately trying to hide something? If they can’t explain how their numbers work, are they the right numbers? What is the opposite of pro forma — the actual numbers?

As I wrote in a previous Friday Workout, one of my first experiences of excess and unnecessary complexity was with an Austrian furniture company Schieder Mobel. After a pulled HY bond in 2005, GS brought a repackaged a second-lien issue a year later. At its height Schieder had 11,000 employees and €1bn in sales and it claimed to be the largest furniture manufacturer in Europe, famously making the iconic Ikea Billy shelves. Incredibly it had 80 operating subsidiaries, with over 50 in Poland alone. The founder Rolf Demuth ended up on trial in 2010 for fraud, credit fraud and balance sheet manipulation, including fictitious invoices with third parties owned by shareholders, with a number of its subsidiaries.

Another example was Croatia’s Agrokor, a vertically integrated food retailer and the largest employer in the Balkans, indirectly controlling 16% (not a typo) of the country’s GDP, with over 177 companies in the group. Its accounting controls (in hindsight) were appalling. In early February 2017, my colleague at Debtwire, Elena Shutova’s research report highlighted discrepancies between local filings for listed JVs and the consolidated reports which caused its bonds to drop 6-7 points. My article two weeks later on potential insolvency triggers and questioning its liquidity position accelerated the slide, and only six weeks later at the end of March 2017 it filed for insolvency. It emerged that €2.2bn was owed to suppliers (including over €1bn of promisory notes) in addition to the €3.5bn of corporate debt. This fantastic piece from Razvan Cosma is the best summary for those who want more on this incredible tale. 

Which leads us nicely onto one of Carson’s most famous credit shorts; Groupe Casino. 

Not only did the French food retailer have a complex group and financing structure, but its accounting was odd and opaque. I remember meeting with arguably the best analyst on the name, Tomas Mannion from Sarria, in spring 2022. To fully understand the business and to model it properly would take at least three months of work, he said. And he wasn’t wrong, as my colleague Denitsa Stoyanova would testify. 

And its not just happening at the corporate level, we are starting to see increased levels of complexity and hidden leverage appear within private markets from the rise of NAV funding, continuation funds allowing them to shuffle and delay the day of reckoning on their investments and their approach towards investing, and financing at asset level. 

Are we setting ourselves up for another subprime moment, where there is such a need for fresh product to feed the beast, the funding machinations in the background keeps the whole game going for another year or two? 

Remember the moment in the Big Short when it was clear to Michael Burry there was plenty of evidence the market was crashing, but the derivative banks refused to change their marks? Complexity and opaqueness can allow you to do this. 

I agree with Jan Loeys from JPMorgan (via the FT):

“Our industry seems to love complexity and abhor simplicity. The more complex the financial world is seen to be, the more managers, analysts, traders, consultants, regulators and risk managers feel they add value and expect to be paid.” 

He adds:

“One should not buy assets that are too complex to be easily understood, as the risk is then that the asset will not be appropriate for one’s financial objectives.” 

Hear, hear. 

I would add that a restructuring journalist should not write about complex deals, unless they fully understand what is being said to them and can explain clearly. But like Jan, I’m old school. 

Carson also says that if management cannot explain and answer analysts questions about the aforesaid complexity in their reporting, that is another red flag. He also makes another good point — some of his best short opportunities come from companies rated BBB, as management stretch the accounting envelope to maintain their growth story and are increasingly desperate to maintain investment grade ratings. When IG ratings are lost, the fall can be precipitous too. 

It is noteworthy that corporate failures such as Enron, Agrokor, Casino (and SBB to come?) were all rated BBB when their problems first came to light. 

However, complexity can also create opportunity too. Or, at least for some. 

The best advisors, investors (and journalists) can simplify the issues, distill a complex situation into the basics and then engineer the best solutions. Navigating complexity is likely to be the key to successfully riding the next distressed wave and avoid a wipe-out.

Shut that window (there’s a downdraft out there)

Despite worries about an imminent US government shutdown, with sharp rises in US Treasury yields, higher oil prices, a rising dollar and sharp falls in equity markets in recent days, LevFin issuance is on a tear. Is this a rush from borrowers to get deals out into the market before the window slams shut, or is something else at play? 

An incredible 18 US high yield deals arrived on Tuesday (Monday was a Jewish Holiday) despite the stormy outlook. Over in Europe, we saw PureGym’s bond refi (9fin’s Josh Latham was spot on with his prediction and our Financial QTis a must-read); a mirror TLB for Altice International taking advantage of an expensive loan market to refi its Jan 2025 SSNs.

With the ELLI trading above 96, we are even seeing re-pricings reappear in the loan market, with Nord Anglia and Gallileo Education launching this week. BTW I’m still getting my head around why investors would want to accept big drops in margin (for arguably overvalued paper) trading just above par — the soft-call (normally six-to-12 months from issue) isn’t that valuable here. You are only losing up to a point — and if you are a CLO you are not even marking to market. 

I’m sure I’m being dumb here and there is a simple reason why holders are just waiving these requests through. Just another fact of life for loan investors. One of the inherent laws of the LevFin universe is that sponsor requests get waved (or should that be waived) through, without much inspection, and never any insurrection. 

The only explanation I can think of is the fear of getting called and being unable to redeploy the proceeds, which could also explain the rationale for paying up to increase your Altice International TLB exposure. Altice suggests that the loan market is so hot right now, that it makes sense for borrowers to tap it to help reduce upcoming bond maturity exposures.

Anyhow, using our screeners, there are plenty of names that could be subject to a loan repricing. The starting point is that 308 European loans issued before January 2023 from 183 companies now trade above par. Of these, there are 83 tranches from 60 borrowers with margins at 450bps and above (at or above market margins). That's a lot of potential repricings to come, with just four loans trading above 101! Asking for a friend, what are the arranger fees like on these deals?

One of my colleagues at 9fin suggests that the repricing trend is the next stage of progression in the loan market arguing that most of the A&E transactions have been done. 

I’m not so sure. 

I agree that the bulk of the 2024 and a lot of 2025s have been addressed, but there are still plenty of late 25s and 26s to deal with. Our screeners have 42 loans from 31 borrowers with maturities in less than three years and loan prices below 92 (suggesting the market has doubt over a straight refi), with less than a third of these residing in our Restructuring Tracker.

While there appears to be limited value in European primary and secondary (especially on a spread basis), if you go down the credit curve the picture changes, or at least in Europe. CCC paper is not only closer to historical wides, but has diverged massively from US CCCs. Your entry point is so much better this side of the Atlantic. 

You might say that Europe is in a much worse position economically than the US. But recession probabilities are similar (see below), so what explains the difference in lower expected recoveries?

Or as Tracy Alloway famously said, is it just all about “flows before prose”?

Technicals are currently trumping fundamentals for primary and a swathe of secondary paper. Not surprising, given that 15% of the EHY market has disappeared in just over a year, and there is around €2bn of redemptions, coupons and refi funds inbound in the next couple of weeks. The pace of CLO issuance is increasing, adding to the FOMO buying going on in loans. 

PureGym has probably done enough to prove itself as robust enough to endure a down cycle, and 10% yields can compensate for a lack of cash flow generation and the risks of its expansion programme. Whether this could extend to a Boparan, or to a Stonegate, or Morrisons is moot. 

It feels like we are back to where we were in October/November 2020, when many of these borrowers (including PureGym) managed to get their stressed refis away, and a couple of months later the window slammed firmly shut. 

Educating Beta

Swedish property company Samhallsbyggnadsbolaget (SBB) is trying to convince investors that it has learnt its lesson and it will finally simplify its complex group and financial structures. Over the past 12 months it has entered into a number of transactions to raise cash and meet short term maturities, and keep its prized investment grade rating. 

One of the largest transactions was the sale of a 49% stake in EduCo — a spin-out of its social infrastructure assets for public education assets — to Brookfield for SEK 9.2bn of cash upfront with up to SEK 1.2bn in possible earnouts. But to get the deal done SBB provided a SEK 14.5bn intercompany loan to EduCo, as per the company’s presentation at the time. The intercompany loan has tenor of up to six years with a fixed interest rate of 3% and there were doubts that it could be refinanced at reasonable rates. 

As its troubles increased, it hoped to offload the remainder of EduCo to Brookfield, but in July talks broke down between the two parties. SBB then resorted to yet another JV, this time for a newly established residential subsidiary, by issuing SEK 2.4bn of preference shares to Morgan Stanley Real Estate Investing (MSREI) which resulted in SEK 2.36bn cash inflow.

There is speculation within the RE market that Brookfield got wind of the other transaction (at a much lower valuation) and got spooked, but it's just a rumour for now. 

The MS preference shares rely on the return of capital on an exit, or by SBB redeeming the shares. SBB can redeem the preference shares at a price equal to an internal rate of return (IRR), on a SEK basis, of 13% per annum up until and including year five.

This transaction aggravated a SBB bondholder group, as they felt the MSREI deal leaked value and primed their debt. By this time they were sending angry letters to the company, asking to be consulted on further material disposals or capital increases. As my colleagues Bianca Boorer and David Orbay-Graves wrote this week, bondholders felt they were able to offer better terms than on offer from MSREI. 

While all this was going on, SBB's ratings continued to slide and recently dropped to CCC+ on elevated liquidity concerns. 

But this week there was finally some positive news for bondholders. 

SBB said it had sold 1.16% of its EduCo JV to Brookfield for around SEK 242m (€20.6m), lifting its stake to 50.16%. EduCo will therefore no longer be a subsidiary to SBB and will not be consolidated into its accounts. EduCo will repay SEK 9.1bn of its SEK 14.5bn intercompany loan from SBB, leaving SEK 5.5bn outstanding. EduCo will then seek a refinancing of its existing current secured bank debt of around SEK 6.9 billion.

This should mean that SBB will now have enough funds to meet 2024 maturities. 

“We always knew the company had this ace up its sleeve,” a bondholder told 9fin. “The first time around the deal was pulled because it was a question of price. Brookfield knows the asset extremely well. It was always the case it could derive a better deal the second time around.”

The CEO of SBB Leiv Synnes told Bloomberg that the intercompany loan repayment was financed by a bank consortium through the loan market, to be taken out by funding in the capital markets. “You could say it’s a bridge from banks, and then it will be a capital markets solution.”

“The rest of the capital will be used to repay existing creditors, primarily Nordic banks. There is a discussion with each bank if it wants to remain in this structure or if they want to be repaid. And of course part of those discussions involve what is most profitable for us and Brookfield.”

So far, so good. The latest EduCo deal has created a lot of educating beta for bondholders with sharp rises in bond prices following the news. 

But Synnes said that more capital is still required to meet the $1.3bn of 2025 maturities. This could come from property sales, IPO or from further partnerships. 

This week SBB presented a new group structure to decentralise the company by establishing wholly and partially owned business units.

SBB claims the new decentralised structure should improve the group’s access to bank funding, enable equity raising as well as improve its financial reporting and transparency. 

In brief

Sticking with the home of ABBA, Freddie Doust has taken a look at the new Swedish Restructuring Plan — Gimme, Gimme, a Plan after midnight — which has quite a few similarities to the Spanish version. One of the quirks is (in addition to a two-thirds approval threshold) there is a two-thirds numerosity test. But as Freddie notes, there hasn’t been any case law precedents so far (it's too new) and many of the Swedish companies we are covering (SBB, Heimstaden, Intrum, Cabonline) were investment grade, so there is plenty of scope under loose docs.

Intrum also features in our latest version of(Not so) Blessed to be Stressed — debt purchaser edition, released earlier this week, which includes our thoughts on Intrum and Lowell. As 9fin’s Nathan Mitchell and Matthew Hughes note “with business model scrutiny amid higher rates, these credits are turning to alternative solutions to address upcoming maturities.”

This report follows on from our recent report on AFE (AnaCap Financial Europe) which is arguably in a bigger bind than its largest peers, and is actively talking to advisors for its RCF and bonds. This week we had the long awaited Q2 23 conference call. But it lasted just over 10 minutes, and despite having a Q&A slide in their presentation, management said at the start there would be no Q&A. 

Victoria Plc bonds took a hit earlier this week after its auditors issued a qualified opinion on its (delayed) annual accounts. In its mid-August conference call, the company said that the delays were due to routine audit procedures. But the annual accounts show that Grant Thornton, the group’s auditors, modified its opinion on Victoria’s account in relation to subsidiary Hanover Flooring Limited (HFL).

And as expected, Casino’s CDS auction settled at a de minimis price, just one cent, giving 99c recovery to protection holders. 

What we are reading, watching this week

Most of my week has been spent reading manuals for domestic electrical appliances. 

As a new homeowner I’m coming to terms with shelling out shed loads of money for flashy new young additions to replace ageing duds, while trying to convince myself I can amortise the cost over several years and therefore justify that the outlandish initial expense is somehow worth it. 

A similar feeling to that of Todd Boehly at Chelsea. 

I’ve yet to read the Supreme Court ruling which says that Mozambique's claims for bribery, conspiracy and dishonest assistance against the defendants are “matters” which fall outside the scope of the arbitration agreements for the purposes of section 9 of the Arbitration Act 1996. This means that the claims brought in the English court will not be stayed and can proceed to trial, outlines Herbert Smith Freehills in this illuminating primer. 

But just when I’m contemplating bunking off to listen into the Mozambique/CS case next week (it took up a few months of a previous reporting life), there is news that UBS, Debit Suisse’s new owners is seeking to settle out of court.

As Facebook faces a lot of flack for the billions being spent on the MetaVerse, there was a meta-reverse, as it paid £149m (seven years rent) to break the lease on its new London base. 

For those who haven’t seen it, would highly recommend Panorama’s — downfall of a Crypto King on SBF, the genius who wanted to use his trading profits to save the world. 

And as Rishi Kingdom Brunel gets ready to host the Conservative Party conference in Manchester, the planned HS2 terminus, there are live scenes from the HS2 just north of Watford 

Showing how screwed our transport system now is, this lengthy live blog tweet of a train journey from London to Edinburgh went viral this week after the train stopped at Preston. 

Mixed fortunes for Brighton, we managed to turn it around at the weekend to beat Bournemouth 3-1 and go third in the Premier League. But we lost 1-0 in the Carabao Cup to Chelsea in mid-week. Next up, Aston Villa away on Saturday lunchtime.