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Private Credit 

Chris Haffenden

I was (briefly, less than 24 hours) in Paris earlier this week at the mammoth IPEM conference — 6,135 attendees! While Blackstone’s Steve Schwarzman was pontificating in the grand hall in front of LPs, GPs and rival funds, I was in a much less grander room upstairs, listening to a dry economics overview given by one of the event sponsors.

This is a well-trodden path at these conferences. It is meant to set the scene and lead into the more meatier panels on the distressed stream, culminating in my Fireside chat with Ben Langworthy from Centerbridge at midday. 

But I was left underwhelmed. The TLDR from the eminent economist was that rates are normalising, there is greater economic uncertainty, blah blah — but the link to how this will lead to more distress, what we all want to know, was sadly missing from the presentation. 

My disappointment was compounded by the next panel, which despite having three big beasts of European distress on it, with decades of hands-on experience, was also a let down. 

Yes, we had big numbers to excite the crowd, a $4trn opportunity, dwarfing the dedicated funds towards it; don’t worry about the low default rate and the ability of sponsors to extend of maturity walls, we are still early in the cycle, activity is rising, this will unfold over a number of years, etc. 

But sadly there were no specifics to feast upon. 

Instead they were all keen to promote their flexibility and how they had ‘more tools in their toolkit’ with buzzwords such as ‘margin of safety’, ‘risk adjusted-returns’ and ‘capital structure solutions’ used numerous times on the panel. Everyone seems to want to invest in a good company with a bad balance sheet! 

Some of these terms also cropped up in pre-conference conversations I had with Ben and some of the Centerbridge team. It’s clear that a lot of investment funds, better known previously for their distressed strategies, have now grown up and evolved a lot in the past decade. 

That is no bad thing, given their poor experiences with European Restructurings in the past.

I’ve seen many distressed funds come and go from the European stage. They learnt the hard way that many EU jurisdictions are not like Chapter 11, and recovery outcomes are extremely variable. Many jurisdictions were much more debtor friendly than in the US and even after a number of positive changes, particularly after the EU minimum standards were adopted, we still can get adverse and variable outcomes, such as seen with Orpea and Casino. 

Case law is still in development, needing an experienced and capable judiciary to navigate the new laws. The odd scary case is emerging, and I highly recommend Will Macadam’s article on the Single Home judgment — Two plans walk into the Spanish bar — where the SME used inter-company debt at its subsidiary level to cram-up and term-out its debt. That may give some funds involved in Spanish situations sleepless nights.

The opportunity set has changed markedly for many distressed funds over the years. 

Yes, there were a number of great investments thrown up by the Global Financial Crisis, and a once in a lifetime trading opportunity from Covid to pick up good assets at distressed prices, but that didn’t last for long, it was mainly a ‘flip’ trade or being able in a limited window to provide short-term emergency liquidity on favourable terms at super senior level.

But since 2020, distressed opportunities have been harder to come by, especially for those players wanting to deploy in size, as financing for risk assets remained readily available, with the maturity wall greatly chipped away, in particular for loans. 

So, with many distressed funds unable to deploy huge amounts of dry powder in public situations, they are increasingly looking towards private markets for opportunities (or have suffered powder burns from Chinese Real Estate). 

Their tactics have changed, loan-to-own is rarely their prime strategy, funds are looking to work with sponsors, taking advantage of loose documentation and baskets to find creative routes into the debt stack often without owning any incumbent debt, with more strategies and financing tools at their disposal than a decade ago.

Which brings me back to the conversations with Ben, and a number of other funds in recent weeks. Many now can choose between taking a PE approach, being able to co-invest alongside existing sponsors, or have the ability to provide structured equity, with often a junior piece providing the best risk-adjusted return. 

That morning I was given an example where a fund was invited to participate in an auction for a financial services asset being sold by a PE sponsor, where the indicative IRR for the equity was in the low 20s, but the second lien touted as part of the debt package was paying 16%. It was an easy decision to make, the private equity team went pens down and phoned their credit team instead. 

As a side note, does this indicate that IRR assumptions haven’t moved wide enough to reflect the increased cost of debt? For the asset above, this arguably should be at least in the high 20s. But that would reduce deal multiples yet further, erode equity cushions and hurt comp revaluations.

The use of junior debt is increasingly happening within the private credit space, with ‘wedge’ financing — effectively bridging the gap between what the direct lenders are willing to refinance, and the equity — plus it reduces the amount of cash interest, a key consideration in the current environment. It is not just mezzanine, many are now willing to offer preferred equity as a solution. 

For an investor with a distressed mindset, despite being deeply subordinated, preferred equity still provides a lot of levers when the deal goes bad, as (if they are smart and tighten up the docs) it prevents leakage to the equity and offers a potential route to control. 

For those looking to know more, a good primer on preferred equity is available here

But Private Equity funds also have more tools at their disposal, and more time (ie optionality), given cov lite structures and sponsor favourable docs to address problematic investments. 

In the past if they needed to support a troubled portfolio company they were limited by the restrictions placed on the fund which made the original investment and its lifecycle. They would either have to go back to their LPs for additional funds, or structure a fund-to-fund transfer (as was the case with CVC for Douglas) and recap via the new fund, rather than the old vintage.

But the rise of NAV financing — effectively borrowing against the whole PE fund portfolio — to raise funds to support individual investments gives greater flexibility. Journalists have gone to town on this, using the example of Vista Equity Partners’ troubled and protracted Finastra refinancing on the evils of using leverage to deal with leverage. 

There is an argument that you are borrowing against good assets and remortgaging existing unrealised equity returns, cross-collateralising a portfolio and creating a drag on performance. It may create governance issues too, as you may become more beholden to lenders to their equity, who may have differing agendas to their LPs. 

At the extreme, you could have a replay of what happened with Dubai International Capital a decade ago, (spoiler alert, it eventually emerged that almost all of their equity stakes were debt financed!) which had to liquidate/restructure its investments to repay its equity lenders. 

Buy me a beer and I can share some interesting insights and war stories on DIC (in hindsight the tick in their logo should have been a cross).

An added layer of complication is that LPs are co-investing in a number of portfolio investments. Making matters worse many are providing second-lien and other junior debt, which can mean that they are at odds with the sponsor in a restructuring situation and arguably are in a better negotiating position. I don’t have the inside track on Wittur or Keter, but wouldn’t be surprised if this dynamic was playing out in their restructuring talks. 

So, the TLDR is that the lines are blurring, not just with financing options (private credit and LevFin, equity/debt) but also between investment funds, PE sponsors, LPs and CLO lenders. 

This can create problems for journalists, as it doesn’t sit neatly with traditional coverage buckets. It requires not just getting up the learning curve on the financing tools (using a Swiss army knife rather than a machete is how one fund described it), but also understanding the evolving dynamic between various stakeholders plus knowing who are the stakeholders behind them. 

In summary, if Leverage Finance and Private Credit is about to be hit by a distressed earthquake as some of the panelists suggest, its epicentre may be well below the surface, and the aftershocks may create more damage for some, rather than the original quake. 

As sponsors look for ways to deleverage their businesses to make them more attractive for refinancing (or to avoid a restructuring, and/or even extract value when they should have no right), more creative solutions are emerging. 

The traditional methods to deleverage are by mortgaging up existing asset(s), often by sale/leasebacks (but it reduces collateral value to lenders and often raises costs) and disposing of non-core operations, or even executing a demerger, where you can offload the bulk of the debt to the demerged entity (Atos, Solvay) recreating a GoodCo rump. 

But what if you own another portfolio company that could provide an alternative solution?

Asda purchased EG Group’s UK & Ireland operations enabling EG Group to complete an A&E for a chunk of its debt stack (with Asda funding some of the purchase price with its own sale/leaseback. Now a rumour reported by Sky News (we understand that it is already in the works) is that Morrisons is to sell its petrol stations to Motor Fuel Group (MFG) for up to £2.5bn. 

As my colleague Owen Sanderson would say ‘two is a trend’.

Both businesses are owned by CD&R. The problems syndicating Morrisons hung debt was well documented, meaning that the ownership in certain parts of the debt stack is highly concentrated. Performance of the UK supermarket group has been poor, losing market share to competitors, and with a vertically integrated food model, it was harder hit with cost inflation. 

The sponsor hasn’t been sitting on its hands, Morrisons has undertaken a number of sale/leasebacks in recent months to help deleverage. Whereas MFG has performed well, and timed its A&E of its loan-only debt structure well earlier this year, and net leverage is below 4x. 

On a standalone basis funding the acquisition with mostly debt could be problematic, but many Morrisons bondholders/lenders will be motivated to support the deal, said one. The sponsor is expected to provide an equity cheque, and arguably re-leveraging the business would boost returns, he suggested. 

But how will the proceeds be applied at Morrisons level? 

As my legal colleagues Brian Dearing and Alice Holian note in recent Asset Sale Analysis the documents are quite bespoke here, meaning that the sponsor “has a lot of flexibility to repay senior secured indebtedness (with no constraints on which senior secured debt is repaid first), as well as potentially generating capacity to make dividends its sponsor.”

This could create some interesting trading opportunities in Morrisons debt. Its floating rate debt is expensive (blame a poor hedging strategy) but you could also see some holders lobby the sponsor to repay their fixed debt tranches in return for providing a chunk of fresh debt at MFG. 

Not so great if you are an existing lender at MFG, with the shape of the financing formed by the hands of lenders elsewhere. 

Which begs the question, should investors be paying more attention and be more mindful of being used as a vehicle to leak value to support other companies owned by their sponsor? 

Next up could be the biggest debt complex in European LevFin, Altice International and Altice France. If as rumoured, Altice Portugal is sold (we hear numbers of above €6bn) what is the ability to support Altice France with the proceeds? Is this enough to deleverage France? What happens at Altice International level? Could they consider merging the two?

There are a number of EHY borrowers with restrictive debt structures which could benefit from restructuring (structures as opposed to cutting debt), such as UK pubs group Stonegate, which we pointed out is over 100% LTV at HY borrower level, but much less leveraged at the Unique Securitisation level. We suspect that a lot of brainpower is being exerted by sponsor TDR Capital (a key player in the EG/Asda deal) over this issue and how to leak value away from the WBS.

Another borrower which is restricted in its financing options is Intrum, the Swedish debt purchaser. 

It faces big debt maturities in 2024 and 2025, and is highly reliant on the high yield market for funding, with only €250m of secured debt capacity. This means, unlike its peer Lowell, it is unable to use securitisation as a vehicle to fund NPL purchases, which is needed to maintain the level of ERC (estimated remaining collections). Otherwise, you end up with a portfolio of NPLs in effective run-off, hoping that there is enough to cover maturities as they come due. 

With its high yield bonds yielding 12-13% (many have sub 5% coupons), maintaining the traditional financing multiple (difference between cost of capital and the IRR it buys NPLs) now means having to buy NPLs at a much higher IRR. With divergence in funding costs of competitors (many have more flexible and cheaper funding options), Intrum is at high risk of losing its competitive advantage in bidding for portfolios. 

Intrum therefore is changing tack, as outlined in its Capital Markets Day presentation and transcript (warning, it’s several hours long). It is aiming to cut leverage to below 3.5x (from over 4.5x) in the next three years. 

The management team says: “Priorities going forward are to grow servicing cash flows and reduce leverage. All available cash flow will principally be dedicated to reducing leverage and improving our financial risk profile.”

As 9fin’s Nathan Mitchell will outline in a forthcoming analysis (due very soon), proposed remedies include pivoting towards an asset management business, pausing dividends, exiting certain markets, cost reductions, and restricting redeployment of capital. 

He believes the largest risk is executing a back book sale, whose proceeds the company says will be “meaningful.” They said any deal will be done at at or about book value. This might be enough to service 2024 maturities, but with SEK 15bn of debt due in 2025, it may have to A&E the remainder, using the remainder of the cash from the sale to smooth the deal. 

Nathan concludes: “On paper, management’s plan makes sense but is sensitive to execution risk. Intrum holds effective levers to generate cash in order to deleverage but perhaps not to the extent or at the speed that management envisages. Instead Intrum will likely continue to have to remain in the high yield market, but due to the gradual deleveraging the cost of financing will likely begin to reduce, making future debt maturities easier to refinance.”

We’ve done at lot of analysis on Vivion’s recent debt exchange, pointing out some of the game theory on whether to remain in the stubs or not. In their H1 call this week, the dangers for stubby holders were made clear, as a chunk of the group’s cash is being reserved as a contingency if it can’t roll or refinance €267m of secured debt. As Emmet Mc Nally writes:

“In terms of the risks for the stubs, timing will be important. Zuker said on the call they are in early discussion with lenders on the German secured debt but that they are unprepared to look at extending the loans until H1 24. There is every chance they would want to see some resolution of the stubs before making a final decision.”

Yet more rolls of the dice for Codere this week, as it emerged that it needed another €50m of interim financing from creditors (on very expensive terms, see Will’s write-up here) to cover operational funding needs and to avoid breaching a minimum liquidity covenant. The Spanish gaming company has indicated it might need to tweak the terms of its latest restructuring agreement (the fourth in eight years) which is due to implemented in Q4. 

The identity of the buyer of Ideal Standard was revealed this week, Villeroy and Bosch for a valuation of around €600m, with the Belgian Bathroom products manufacturer disclosing that 99% of holders had consented to the transaction. 

Yet another business update from Casino this week, and surprise, surprise, yet more weakness at its hypermarkets division. It also announced an outline agreement with its Quatrim bondholders (which have claims over most of its supermarkets and hypermarkets real estate) which on the face of its seems to be a home run for the Quatrim bondholders. But the strike-out of the unsecured bondholders was confirmed in the CDS auction, which settled at one-cent. 

We also had confirmation this week of 100% lender consent for Flint and Keter transactions — which means they avoid English Schemes and full disclosure, boo. 

Spent a lot of time on the Eurostar this week, which enabled me to catch-up on a number of podcasts, as the train wifi failed to connect, leaving me digitally dark. 

I particularly enjoyed Richard East, founder of Quinn Emmanuel’s London Office, talking about the key differences between litigating in the US and UK. 

I would also recommend in addition to 9fin’s excellent Cloud 9fin, Oaktree Capital’s Wayne Dalhl opining on why credit spreads remain surprisingly tight.

Akshay Shah, infamous for his Codere CDS trade while at GSO, tells Bloomberg that creditor on violence is happening in Europe with bitter fights between creditors to get better returns on distressed companies.

Behind closed doors, where do private credit real estate funds really think their NAV is?

And this week, French Asset Manager Perial Asset Management (Perial AM)reduced the valuation of its four RE funds(were €5.4bn) by between 8.9% and 16.3%, “look out below.” Unfortunately no corporate invites to Octoberfest this year. It is becomingly increasingly expensive, but is this due to all the corporate boxes? At least you will be saved the sight of seeing me in Lederhosen.

It’s been a week of highs and lows for Brighton. A footballing masterclass to beat Manchester United 3-1 at Old Trafford, with thesecond goal including 30 passes, showcasing De Zerbi ball, to our first European night in 122-years, but losing 3-2 to AEK Athens.

Our starting 11 at Old Trafford cost around £18m. It was disclosed this week that our 18-year Irish centre forward (and United fan) was subject to a £50m bid in the summer from Man U, but this was rejected, with Man City making him their top priority next summer, willing to pay £120m! 

Finally, my Apologies for the lateness of the Workout. Arrived home at 1am from the game last night, still soaked through after a two hour drive as the heavens opened while in the park n’ride queue. Bournemouth on Sunday,

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