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Chris Haffenden

Markets rally for many reasons; it is not always just due to fundamentals; it can also be down to technical factors and/or investor flows. Positive price action in the wake of bad news, especially at market low points are often signs of a near-term turning point. In hindsight, the reaction we saw post the US CPI print a couple of weeks ago is one of those events.

Sure, markets can often get ahead of themselves and can rise just from a lack of selling which gains momentum as shorts are forced to cover. The old adage, rings true — just how much was already in the price? Harry Hindsight is still the world’s greatest trader.

An old boss of mine once said, you shouldn’t bet on Armaggedon, it rarely happens.

The sense of panic we saw a few weeks ago has abated. Bond vigilantes have won out for now, with the newfound focus on fiscal stability. The LDI debacle has also helped the technical picture for bonds amid nervousness from central bankers whether hidden leverage in strange places in the UK could happen across the Atlantic. QT might be delayed, or tempered.

A WSJ article last week saying that the Fed would rise just 75 bps in November and moderate its rises thereafter has helped risk assets, despite recent Q3 tech earnings, with poor Meta Data, bad Intel, and a big miss from alphabet. Worse than expected economic numbers and fiscal stability fears mean lower terminal rates and less sharp rate rises to come.

On Wednesday, we even heard the refrain of O Canada, as their Central Bank (one of the first to tighten) raised rates by 50 bps rather than 75 bps expected and talked more dovishly about rates. Comments from the ECB yesterday, after a 75 bps hike to 1.5% were also more dovish leading to expectations that the terminal rate may now be as low as 2.75%.

Cue talk for yet another Fed pivot, I make this the sixth one this year. We all know how the last five ended!

For now, bond markets have picked-up the pivot baton. Government yields have posted decent drops of late, and US 10-year yield might be breaking down through its recent up channel, notes the Market Ear.

On balance we could be in for a more positive November, after all the travails of October.

This might allow some more deals like this Ineos loan and Cirsa’s bond refi to come out of the woodwork, before the next unforeseen event leads to the bear reawakening. At time of writing, the iTraxx Crossover is at 565bps, well inside the YTD intraday wides of nearer 700 bps.

From a fundamental basis, there are some reasons to be cheerful:

The inflationary pressures caused by the Russia/Ukraine war are lessening. Gas storage is full and prices are coming down fast, we even saw intra-day pricing go negative this week.

Global supply chain problems from the Covid-period demand splurge are easing, despite hiccups from China’s zero Covid policy, with shipping container costs now back to pre-crisis levels. Even the delayed China GDP numbers were better than forecasts, albeit half their old 7% target.

But the wider macro environment is still challenging, with expectations of a widespread recession globally (US might escape), seen by Central Banks as the acceptable cost of getting inflation under control. Post QE, interest rates are normalising, with the era of cheap money and abundant liquidity coming to an end. Inflation, while on a downward trend, is likely to remain at elevated levels for at least another 12-months. Housing and commercial real estate markets are crashing globally, and record corporate margins are coming under pressure.

For LevFin, the technical picture remains challenging. The IG tourists are gone — IG is arguably better relative value — and outflows continue, around 20% of AUM in 2022 alone for EHY.

Heading into 2023, EHY issuers face a challenging environment with lower cash buffers, as BNP’s HY credit desk pointed out this week. They expect credit deterioration to extend to interest coverage and leverage as maturities approach.

“It is no longer true that High Yield fundamentals are strong.”

Contrary to investor belief, the maturity wall is closer than you might think.

The share of debt maturities due within two years is rising and now close to all-time highs across both ratings and sectors, notes BNP.

The maturity wall is especially elevated across single-Bs (10% of issuers have maturities in two years compared to 5.7% historically) they note. But these single-Bs trade tight due to a sharp drop in primary issuance.

The average single B coupon is 4.5% while current Yield to Worst on Bs index stands at 10.2%, they note. While interest coverage remains high, if your interest costs more than double, it can halve very easily as per chart below.

One CLO investor said to us earlier this year, that his list of concerns at the time were beds, sheds and deads. He even got the order right, with Hilding Anders first to restructure, while Keter launched an A&E a fortnight ago with a coercive element, still no news on whether it went through btw.

On Wednesday Orpea announced its second conciliation procedure with its creditors in five months. The first procedure with its bank lenders was approved in June 2022 and resulted in the injection of €1.73bn new money and up to €1.5bn of optional liquidity subject to a €2bn disposal plan.

So, why the need for a second? The latest one won’t be a surprise to 9fin subscribers.

Our report in late June didn’t hold back. We said that the French Care Home operator was running out of liquidity runway despite the significant additional support from its lenders. Its real estate portfolio was at risk from rising interest rates and its plans to raise cash by selling off over €2bn of properties would reduce asset coverage for creditors.

“In our view the disposal plan will not only stretch the group’s net leverage ratio but will also erode the unencumbered asset coverage for unsecured creditors from 72% currently to 57% in FY 26.” said Denitsa Stoyanova 9fin’s distressed analyst.

Following allegations of misconduct and mismanagement of funds in early 2022 (see our ESG Quicktake for more details), the auditors delayed signing off the FY 21 accounts by nearly two months due to the extra time needed to assess the additional risks.

A new management team were tasked with rebuilding its reputation and pulling off their ambitious turnaround plan.

But H1 22 numbers were worse than expected. While occupancy rates have started to improve, operating costs surged (staff costs rose 13%) and Covid-19 support from the French Government has gone. If anything, prospects for the second half were even worse, with the deterioration continuing, cautioned management.

The earnings report spooked the market. The 2025 SUNs tanked from the low 70s in early September to languish in the mid-40s as of 23 October 2022 the day that trading of all equity and debt instruments was suspended by the AMF pending an announcement.

On Wednesday, management confirmed that they are embarking on debt restructuring with creditors via a court supervised conciliation process. The mighty Hélène Bourbouloux, a fierce negotiator and veteran of high profile French restructurings over the past decade is charged with leading negotiations with secured and unsecured lenders and bondholders. Wider stakeholders such as contractors and suppliers are not affected and the business operates normally.

The upcoming negotiations will be supported by a new business plan to be disclosed on 15 November 2022.

But we do have a decent outline of what is likely to happen.

Orpea in its release has already indicated it is considering equitising its unsecured debt, and unsurprisingly the bonds dropped sharply, down 20 points to be quoted in the mid-20s

Management clarified it is keen to consider the following three options:

Debt-for-equity swap of up to €4.4bn of unsecured debt issued by Orpea S.A.

Amendment of the "R1" and "R2" financial covenants that are attached to €3.3bn of unsecured bank debt, which will not be impacted by the equitization

Liquidity injection from new super senior debt, which will be secured on currently unencumbered assets

The key to recoveries will be the level of impairments on its real estate portfolio. In hindsight, Orpea operated more like a Healthcare REIT than a care home business. In H1 22 the €8.4bn of real estate assets were valued at an average cap rate of 5.27%. In June, we had suggested this was no longer realistic in a rising interest rate environment and that impairments were likely.

This week, management said it has examined €5.8bn of real estate assets (out of the €8.4bn above) and estimates those will be subject to €0.8-1bn impairments (equal to 17% of €5.8bn). This leaves another €2.6bn of real estate assets that are pending re-valuation, which creates risk of write-downs of ~€450m per our estimate (assuming €2.6bn is also haircut by 17%).

But the impairments are unlikely to stop there, further changes to WACC and real estate yields by year-end may results in further write-offs. 

Management has guided 0.25% rise in the cap rates would lead to €240m drop in asset value — assuming 250 bps rise in risk free rates, equates to €2.4bn — ouch!

Looking at WACC, Denitsa Stoyanova estimates that a 0.5% increase in the rate used to discount cash flows could lead to around €500m of impairments to intangibles — double ouch!

While the €4.47bn of senior secured lenders are in a better position, it looks as if junior bondholders and Schuldschein could face severe haircuts. Back of the envelope calculations based on the above would suggest 50-60% haircuts, and recoveries in the 40s at best.

We will produce a more detailed analysis, after the company provides more detail in its business plan in Mid-November.

Boparan bonds rose sharply yesterday (27 October), up around five points after a strong set of Q4 22 (end 30 July) earnings numbers, with its November 2025 SSNs in the high 60s.

Adjusted EBITDA margins have recovered back to the levels seen at the time of its 2019 refinancing, improved from 5.3% in Q3 to 5.7% in Q4, but 1.6% of the YoY improvement this was catch-up from previous periods on poultry pricing and reimbursements from customers on unrecovered feed price inflation recoveries, with the underlying margin at 4.2%.

LTM EBITDA, after narrowly beating the £75m minimum EBITDA covenant in Q3, came in at £99.5m in Q4 22. An improvement, but still well shy of the £150m figure used to market their stressed bond refinancing in late 2019.

The Q4 numbers were boosted by phasing impacts from pass-thru recoveries, and FY 23 (end 30 July) could be more challenging with further cost inflation mitigation yet to be negotiated with key customers.

As our credit analyst Emmet McNally previous wrote in his write-up of the Q3 22 earnings, if Q1 22 was the worst it was going to get, Q3 and Q4 are likely to be as good as it gets.

Boparan has been successful in removing the time lag on feed price pass-throughs with the establishment of monthly price ratchet contracts. Greater customer numbers were brought on board and more inputs in feed prices (i.e. aside from wheat and soy prices) are now included. “This will stabilise margins going forward and is certainly important in light of the challenging macro environment.”

Round 5 of inflation recovery is underway, notes Boparan who adds that as well as ratchets for ‘external commodity pricing’ there is also a cost inflation basket adjustment in the pass-thru mechanisms with key customers.

While the cost of living crisis is affecting consumer demand, the company says that a move to cheaper meat products such as Chicken from red meat, has resulted in stable poultry volumes. It notes that sales growth is not necessarily linked to price inflation for various meat cuts.

The quarter ended with a significant disruption in their agricultural base delaying the placing of birds onto farms, which management said would have a material financial impact. High temperatures in the summer caused higher mortality rates and weight loss to the surviving birds, said management in call yesterday.

Avian flu is also having impacts, while its farms have escaped the brunt of the pandemic, adjacent farms have been impacted, with Defra restrictions causing logistical issues (exclusion zones, higher disinfection, etc).

For more details, look out for a standalone report, later today.

Metalcorp management told bondholders yesterday that a cross-default on its 2026 SSNs is not imminent. They claimed that the 30-day grace period before a cross-default is triggered has not begun. To start the clock, holders of the company’s 7% past-due senior unsecured notes would need to “invoke” default, it said.

As we reported earlier this month, the company failed to redeem its 2023 SUNs (of which €70m is outstanding) when they matured earlier this month. At that time, Metalcorp said it failed to repay the notes after an expected term loan financing fell through. It said that alternative financing could not be secured in time to execute the redemption.

Yesterday’s investor call came after bondholder’s failed to reach a quorum on an amend-and-extend proposal for the 2022 SUNs. Only 28.6% (by value) of noteholders participated in the vote between 22-25 October, well below the 50% required. A second bondholder vote, at which the quorum reduces to 25% of principal, is due on 18 November.

After experiencing a severe drubbing in recent weeks partly driven by a downgrade to triple-hook of its SUNs there was some blessed relief for beleaguered Groupe Casino bondholders following the release of its Q3 numbers, which optically looked better than many had expected. The SUNs complex rallied 5-6 points on the news, into the mid 40s. The French retailer also announced it is considering selling part of its stake in Assaí for around $500m and a tender today for the €188m remaining on its 4.4561% notes due in January 2023 at par.

Ceconomy, another under pressure retail name, also saw its bonds trade higher this week. Thankfully, there were no further cuts to guidance in its FY22 trading update, the Germany-based electronics retailer reported an adjusted EBIT of around €200m, in the upper region of revised guidance. After diving sharply from the low 70s into the mid-50s following a double notch downgrade by Moody’s in September, the bonds are 62.25-mid at time of publication.

There was lots happening in my old EM beat this week. After years of prevaricating, South Africa is set to assume between one and two-thirds of Eskom, the electricity utility’s $22bn of debt. In a budget update on Wednesday, the finance minister said that details will be thrashed out in time for the national budget early next year.

The TLDR is that South Africa had provided contingent guarantees on the bulk of Eskom’s bonds and will now have to assume some/all of these onto its balance sheet. Incredibly it was in July 2018, that I scooped that advisors were hired for ‘balance sheet optimisation.’

After last week’s raid on offices of SIGNA Development’s founder Rene Benko, the FT provides a profile on the Austrian billionaire with influential friends in high places. He has stakes in the Chrysler Building, Selfridges, and lots of luxury hotels, resorts and offices.

“He likes to joke that only two people have more prestigious real estate under their control in Europe: the British Monarch and the Pope.”

The Atlantic is scathing about the UK in their leader:

Promising stability and integrity there is a new incumbent in Number 10. It will take a Braverman than me to opine on this, so I will leave it to Larry, the Downing Street Cat:

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