There are secondary effects too from higher oil prices, such as a rising dollar, and these petrodollars (bear in mind an increasing amount are no longer paid for by greenbacks) are less likely to flow back into the US and Treasuries making it harder to service US government deficits.

The last time that energy prices spiked during the Russia/Ukraine war, the US government was able to use its strategic reserve to help keep a lid on prices. 

But the SPR is at its lowest levels since 1983 covering just 46 days of supply, after the Biden government missed an opportunity to replenish at around $70 (its preferred buying level) this summer (it had sold its reserves at an average price of $95 in 2022).

US shale might take up some of the slack left by Saudi Arabia and Russia, but production levels are yet to pick-up as companies favour earnings over higher production, with prime tier-one acreage almost exhausted and shifting to less productive tier-two sites. This means production is likely to be capped at around 13-13.5 mbpd, so others will have to cover the shortfall. 

All the above means oil prices could rise higher and faster than expected. 

No circular flow

In the past, elevated oil prices used to translate into a higher dollar (good from an inflation perspective, but traditionally bad for EM assets) with dollar revenues from oil producers used to being recycled, typically from purchases of US Treasuries and other dollar reserves proxies. I remember this first hand as a US dollar Eurobond trader, as once per week at around lunchtime (before the US market came in and liquidity improved) being asked to bid/offer AAA names in 50m clips to SAMA — the Saudi Arabia Monetary Authority. 

But Saudi Arabia’s US Treasury holdings are at a six-year low — with surpluses will be invested in domestic investments such as NEOM, the four megacities project; the Red Sea Development — ultra net worth ecotourism; while also diversifying into sport (LIV, Newcastle United Football Club) and making various direct, private equity investments such as Uber. 

This doesn’t bode well for the US Treasury which desperately needs to find foreign buyers to service the expanding fiscal deficit (around 9%) with record Treasuries issuance at a time when the Fed is reducing its holdings via QT. Even assuming long-term rates of 4%, interest outlays are projected to comprise more than 50% of the total (see below).

Any buyers strike is compounded by the reduction in purchases by the Chinese, who see better returns elsewhere — and may be wary that the sequestration of Russia Central Bank assets may one day happen to them. Let's hope the massing of troops/ships in recent days off Taiwan is just another war game exercise. 

As Kevin Coldiron writes in Epsilon Theory, between 2011 and 2022, China and oil/commodity exporters collectively bought over $2trn of Treasuries. 

The large US current account deficit saw dollars flow from US to Chinese companies who sold them to the central bank in exchange for local currency, elevating foreign exchange reserves, with a large portion invested in US Treasuries.

But China has been diversifying, and has been using the dollars not to build reserves, but to invest in domestic and foreign assets, the most high profile being its belt and road initiative.

This has been happening for a while, and ‘international financial centres’ took up some of the slack (on whose behalf is moot), but as Coldrin writes “the real whale was the Fed” which bought $4trn in this period. But it is now a net seller.

“In other words, some huge buyers want to stay on the sidelines. Meanwhile, the huge seller – the US government – is going to sell even more because it is projected to run large deficits for…well, forever really. And this projection assumes long-term rates of only 4%. 

So the big question is whether 4% yields is enough to attract buyers?

If you believe inflation will be 2% then probably yes, says Coldrin 

“If you believe inflation will be 3%, 4%, or more…then no, bond yields need to be higher. But with rates at, say, 6% the ugly deficit picture above gets uglier,” he adds.

The TLDR is financing the US deficit could be harder than expected — and could crowd out other fixed income investment— meaning yields and spreads (most notably for risk assets) may have to rise further from here. 

Positioning here is divergent; asset managers are very long and hedgies very short. 

So who is right? Jamie Dimon is in the camp that yields will have to go higher. He said he would not be surprised if 10yr yields hit 5.5% and could easily see oil rising to $120-$150.

Wake me up when September lends

This headline is so good, I had to borrow it from my LevFin colleagues

As my colleague Dan Alderson writes, September isn’t normally a good month for credit. Typically the busiest time for primary, and as I noted recently, secondary pricing is very tight, therefore increased supply should push spreads wider. Historically, spreads have tightened in September in just 39% of cases, notes Deutsche. 

But most of the European issuance so far in September has been in double-Bs and these deals have priced tightly, showing no sign of weakness. A rare outing for a solid single-B credit also resulted in significant tightening from IPTs for Banijay which ended up pricing its SSNs at 7%. 

Perhaps a better test of the market will be appetite for the jumbo financing for Worldplay, the first pure play large LBO of the year. After a dearth of deals, my LevFin and Private Credit colleagues are back writing about new debt financings after a meagre diet of refinancing and A&Es. We even saw a rare sight, a re-pricing (Nord Anglia), real bull market stuff.

Leveraged loan prices (measured by ELLI) are at lofty levels, in August they broke above 96, the highest since March 2022. Distressed loans (below 80) are just 5% of the index, notes Deutsche, with the default rate in CLO portfolios steady at around 1.8%, despite the high profile defaults of GenesisCare, Casino and Wittur.

But we are in the business of looking forward not backward. 

After all, policy effects take a while to take hold, and the US Lev Loan, US HY Bond, and EU Spec-grade defaults are at 4.4%, 2.8%, and 2.9% on an issuer- weighted, trailing 12m basis, and close to Deutsche’s projections (made last November) below.

Deutsche doesn’t expect to see the peak in defaults until the second half of 2024. One not so fun fact from its report is that 70% of Eurozone business debt is floating rate! It also points out that despite the record speed in ECB rate hikes, the real policy rate is still negative and loose historically — even after yesterday’s 25bps hike taking it to the highest level since 2001.

Deutsche’s structured finance team notes that despite the raft of A&Es, there are still 70 obligors with bonds or loans maturing by the end of 2024 (€4.5bn). Of this sample, 21% are trading below 80, and 37% are rated triple-C by at least one agency. 

This leaves plenty of scope to boost the default rate, and bear in mind maturity is not the only trigger for defaults. I will leave the final word on this to Deutsche’s strategists who still expect notable spread widening by year-end:

“We always expected this default cycle to slowly gather momentum over time, with termed-out maturities beyond 2024 and private equity cash delaying a sharp rise in defaults. But with real rates on the rise and margins set to compress given sticky wages, we don’t see a credible mechanism for default rates to turn sustainably lower.” 

Is IGM Resinating with investors?

While searches for soft landings have gone off the charts in recent months, another increasingly popular term is de-stocking, blamed for H1 23 earnings weakness in the Chemicals, Pulp and Paper, Retail and Luxury sectors. 

The poor financial performance of LevFin names affected by de-stocking such Ineos, Arxada, Italmatch, Lecta and Sappi is well documented, but we’ve been on the hunt to find out more about private leveraged loan names which are suffering the same fate.

This week, another sticky situation came to the light. IGM Resins, the Dutch “leading provider of energy curing raw material and technical solution provider,” has come unstuck for its sponsor Astorg, with its loans falling from the mid-70s in March, to below 50 last week. 

Faced with a breach of its leverage covenant (RCF lenders had waived Q1-Q3) it told lenders in an August meeting that it had decided to repay 60% of its fully drawn RCF to avoid testing. With €33m of cash as at end-July, the €30m revolver repayment would exhaust almost all liquidity. 

We are told that one lender expressed their concern over the preference given to a small cohort of RCF lenders, adding it would only give a few months of optionality before having to refinance the debt stack — the €325m TLB is due in July 2025, and the €50m RCF in December 2024 (extended from June). They also suggested IGM seek confirmation from RCF lenders that they wouldn’t restrict access to the revolver, given potential issues around going concern. 

I have some sympathy here with the aggrieved TLB holder. 

Rule 101 of restructuring is don’t use up precious liquidity when you don’t have to, especially if you have maturities looming. Leverage is north of 10x and the hoped for improvement in fortunes in Q4 is far from certain, therefore refi hopes (absent a sponsor injection) remain slim. No wonder that par lenders have been exiting in droves this year (we hear of numerous trades in the TLB, including €8.8m in the high 40s last week). 

IGM says that no advisors have been appointed, which we would take as a negative, not a positive. They should be getting ready given the liquidity and maturity issues. Management declined to give rolling 13-week cash flow forecasts, and refused lender update call requests for September and December, telling lenders that they will only schedule a call when they have more visibility on the market recovery and progress on cost savings. 

Not great lender engagement, and we can see why the company responses are failing to resonate with investors. As we revealed in our initial piece earlier this week, LTM EBITDA to July is just €12m compared to €39.5m for FY 22. Performance has deteriorated in H1 23 with just €3m of EBITDA to end-June compared to €25m in the same period of 2022 (source: Moody’s). 

So, what are the issues affecting the business? 

IGM produces photoninitators (compounds which react to light and become electronically excited) and energy curing resins used for sealing, bonding and coating. End markets are split between printing and packaging (50%), industrials coating (35%) and electronics (15%). 

It is suffering from low demand for its UV curing materials, and while market share is holding up in the more profitable specialty silos, its commoditised business is seeing significant price pressure, most notably from Chinese producers which it claims are selling at unprofitable levels. 

IGM recently closed its unprofitable US plant in Charlotte, and hopes that production from new sites will improve competitiveness. Its Litian investment — a Chinese producer of energy curing resins hasn’t gone to plan, with the company telling lenders that production has been limited by waste permits amid low local demand. It recently decided against buying the remaining 49% of the business, saving it around $18m. 

Watch out for a more detailed piece from my colleagues shortly. 

Beauty is in the eye of the debtholder

Beauty products and fashion is a small subset of the European LevFin market, but is one which has seen the biggest price volatility this year. 

This is perfectly illustrated by Isabel Marant, whose bonds sunk another five-points after releasing disappointing Q2 23 earnings. The €265m 2028 SSNs which priced at 8% in February — refinancing outstanding debt and helping the sponsors net a €60m dividend — are now indicated at 83.5-mid, to yield 13%. 

The France-based branded luxury fashion group blamed soft trends in business-to-business and ecommerce (orders down by 11%), strikes in France, and lower levels of Asian tourists to Europe. 

On the conference call there were a number of questions over the wisdom of buying back €20m of convertible bonds from its shareholders, leaving liquidity of just €60m. The company responded that this shows confidence in its ability to generate cash flow in the coming months. Buybacks of its latest bond, are less likely, and while not out of the question, it has to be balanced with the cash needs of the business, it said under questioning. 

The Isabel Marant earnings presentation is here, and the transcript is here

Late last year, The Hut Group (THG) raised a £156m 2025 TLB via a subsidiary, which temporarily primed the existing £600m 2026 TLB, leading to a downgrade by Moody’s and an explainer from our legal team on how they managed to incur the additional debt under the docs.

A former stock market darling, THG bet big and early on digital retailing and wowed investors about the potential of its Ingenuity e-commerce platform. But shares have fallen 88% since its London Stock Exchange debut three years ago, and yesterday’s H1 release saw another 20% wiped off the share price. 

During the first half, the group’s top line fell by 9.3% (including a worrying 14.9% drop in Ingenuity revenues) but EBITDA showed some improvement to £50.1m for the first six months. The beauty division suffered from the “well documented de-stocking in the beauty industry,” with adjusted EBITDA from this segment falling by 40% YoY. 

The presentation was positive about full year prospects citing lowering costs and streamlining of operations. THG is aiming for £120m of EBITDA for FY 23, as the beauty division returned to growth in August after being held back by short-term global de-stocking. It cited a number of key wins and strong pipeline for its Ingenuity division, which is pivoting to larger, more complex enterprise clients. 

But this is still a far cry from the transformational growth stock story from a couple of years ago. THG is yet to generate sustained cash flow, and Moody’s has adjusted gross leverage at over 8x, coming down to around 6x by the end of 2024, when its RCF comes due. 

One questioner on the conference call summed it up very well:

“But you’ve got half of you capex each year on intangible assets, which I think relates to Ingenuity. But if anything, Ingenuity I think reached its peak in 2021, and has been declining even after you strip out the kind of non-core and contracts you are trying to exit. So could you help me understand how you spend over two, four, six or seven hundred million of capex [in total] without any obvious EBITDA benefit from Ingenuity and kind of other growth?”

While the stock continues its re-rating, with the company losing its unicorn status, its loans have performed well in recent months. The 2026 TLBs wrapped around 95, a significant improvement from the low 70s in February. 

In brief

Tullow Oil is looking at raising an oil offtake-linked facility as a possible option to tackle its upcoming debt maturities,9fin’s David Orbay-Graves revealed earlier this week. An offtake-linked facility is a type of prepayment loan, which is repaid by delivering oil rather than in cash. Such facilities are generally provided by commodity traders — such as Glencore, Trafigura or Vitol — or by international oil companies. Tullow’s maturities include its $633m-outstanding 7% March 2025 senior unsecured notes and its $1.6bn-outstanding 10.25% May 2026 amortizing senior secured notes. It also has an undrawn $500m super senior revolving credit facility (RCF) that matures in December 2024.

Pro-Gest dodged questions over a potential refi in its conference call last Friday, which was beset with technical issues, cutting short the Q&A session, reveals 9fin’s Denitsa Stoyanova. The Italian paper and packaging company had a weak first half, blaming de-stocking activity from clients looking to empty warehouses. It says that trading over the summer has improved, and cash burn has reduced. Leverage, however, remains elevated at 7.7x. 

Ideal Standard announced earlier today that 99.25% of bondholders had voted in favour of amendments to the docs, including a reduction in the CoC price to 72. With the 90% threshold passed, the doc changes and exchange have become effective for the 6.375% SSNs due 2026. For an overview of the exchange and consent request from the Belgium based bathroom products group, click here

Maxeda bonds rose sharply yesterday after the release of Q2 23 results. Despite a tough July as wet weather impacted sales at its Dutch and Belgian DIY stores, performance was on par for the same period from last year. The 2026 SSNs are now in the high 70s, yielding around 12%, well above the low 60s in November, when distressed funds saw value. 

Less than six-months after KronosNet took out its TLA bank piece via a TLB add-on, lenders are concerned about a potential liquidity squeeze at the Spanish business outsourcing and call centre group, writes 9fin’s Laura Thompson. It has now drawn down €162.5m of its €175m RCF, according to buyside sources, with €54.5m cash on the balance sheet versus YTD negative FCF of €56m, impacted by working capital hits from its Americas business.

What I’m watching/reading this week

Most of this week has been spent on economic research and ploughing through data releases on both sides of the Atlantic. I have been preparing for a fireside chat with Centerbridge’s Ben Langworthy at IPEM Paris early next week, which closes the distressed panel sessions. 

As a Sovereign debt restructuring nerd, I was intrigued by the curious case of a small bank in St Kitts & Nevis which is holding out against Sri Lanka’s sovereign debt restructuring, after amassing a $250m bond position. As Robin Wrigglesworth from the FT outlines, there are doubts over the affiliations of Hamilton Reserve Bank and its association to Fintech Holdings and the controversial businessman Benjamin Wey. 

It’s 25 years since the collapse of LTCM, the academic hedge fund which blew-up holding a bunch of cheap but highly illiquid securities. This makes me feel very old, as I participated in part of the market unwind of some of its choicer EM positions. I would highly recommend this LTCM 25 years on podcast. 

Another bond market veteran is Bill Gross who made the headlines this week, by saying that to be a bond king, you need a kingdom. Less well publicised, was his appearance on Bloomberg’s odd lots podcast where he called the end of the great bond bull market. 

I’ve lost count of the number of situations in recent years, where smart investors claim to find somewhere in the capital structure with a double-dip, giving them improved recoveries. Rarely do these materialise, especially this side of the Atlantic. This King & Spadling note on the recent At Home Group double-dip financing explains well, how the transaction was structured. 

Lead paragraph of the week from the FT: Deadbeats, the word on the street that your Fibonacci chart is out:

“Investment banks keep technical analysts on staff for the same reason that health services employ chiropractors. Evidence of efficacy is weak but some customers seem to like it and may strongly believe they’ll benefit, and no good comes from seeking to prove them wrong.”

Its almost exactly six-months since the collapse of Silicon Valley Bank. The risks from higher rates for regional banks haven’t gone away as this tweet (what do we call them now under X?) outlines perfectly

On Tuesday, we saw Brighton’s captain Lewis Dunk make his second appearance for England, with a masterclass performance against Scotland. He’s come a long way since winning League One in his debut season in 2010 and his legendary status amongst fans was secured years ago.

And who would have thought that Brighton would sign a player on loan with a €1bn buyout clause? As Sid Lowe from the Guardian writes, Ansu Fati, the Barcelona prodigy given Leo Messi’s number 10 shirt was Barcelona’s great hope: the chosen one, beloved by everybody. There was something about him, a genuinely special player guided by a star. He was magic, one teammate said. He was daring, electric, unstoppable. 

Can he regain his form under our great motivator Roberto De Zerbi? If he can, it could be the most inspired signing in years.