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Chris Haffenden

In last week’s Workout we highlighted the extreme fear in bond markets and whether we should be in the Hunt for Black October. But a week later, we’ve seen a sharp reversal, with yields tumbling across the globe, variously attributed to a flight-to-quality after the events in Israel, with a number of Fed governors and ECB board members this week calling the top on rate rises. 

By Wednesday’s close, 10-year US bonds were 31.5bps below their intra-day peak last Friday (after the jobs report), with just a 10% chance of a hike in November from 31% last Friday. Over in Europe, 10-year Bunds were 20bps lower with the yield curve flattening significantly. Despite a sharp back-up in yields following a slightly higher than expected CPI print yesterday, there are still plenty of bloodied shorts out there. 

So, is there anything we can garner from the whipsawing price action from the past fortnight? 

It is worth noting, that often at times of panic, there is selling into a vacuum, which magnifies the downward moves. The subsequent short squeezes can often be savage, as there is no-one left to sell. Hedge funds (short-term un-patient capital) are very short Treasuries (in particular in the short-end) while asset managers (long-term patient capital) were heavy buyers in recent months.

But can the deluge of long-dated Treasury supply be digested? Wednesday night's 10-year auction might be indicative, with the longest tail in several months. 

Either the Treasury yield spike was a blow-off top and yields are heading lower — or just another bear market rally and rates are going above 5%. We will have to wait and see who’s right. 

But one thing is clear, volatility remains elevated for bonds, which should be bad news for risk asset premia and particularly equities. In addition to the largest upward move in yields in almost half a century we have had over a year of elevated bond volatility. 

As Deutsche analysts noted earlier this week the ICE MOVE index averages 93 from when calculations started in 1988. But since the Fed started its hiking cycle it has averaged around 122 (119 for 2023, despite getting close to terminal rates). It’s noteworthy how strong the negative correlation is to the S&P 500 — 60% of the time when it dipped below 100, equities were “comfortably positive” on a weekly basis. Deutsche adds the dip below 100 in mid-September coincided with peak soft-landing fervour, before the recent savage rates sell-off. 

“Somewhere in the 100-150 bucket for the MOVE, equity performance pivots from positive to negative on average. So recent MOVE levels are broadly consistent with that pivot point,” says DB.

It is also worth noting that of late equities (in particular the NASDAQ) have not reacted as before to upward movements in long-rates, the negative correlation appears broken, or at least for now. 

This has led to a collapse in the equity risk premium — the yield premium to risk-free assets to compensate for greater risk — to near zero (0.766% for the S&P 500, according to Dow Jones data), which is almost unprecedented, being the lowest since 2002. 

With equity volatility as measured by the VIX remaining low on an historical basis, and lower than MOVE, could you make an argument you need to be compensated less?

Some could say that risk free assets are a misnomer given the huge drops in prices (rises in yields) for Government bonds as rates rose (I’m not getting into the argument of whether banks should be marking these to market or not).

My favourite example remains Austria’s 100-year bonds which if you bought at the top, would have resulted in a 70% capital loss.

As FT Alphaville cheekily points out, this is a worse performance than the 100-year bond from Argentina issued at around the same time, which has defaulted and restructured since issue! 

That shows the effects of duration on low coupon paper issued in the ZIRP era. The Argentine bonds had a much lower modified duration (of just 8) given the much higher coupon at issue for the serial defaulter — you should model in at least five defaults during its lifetime — compared to 42 for the Austrian centurion. That makes a huge difference. 

The even longer duration Austria 0.85% 2120 bonds trade at cash price of just 33, but the winner (or should that be the loser) is the UK Gilt 0.5% 2061 which is at a cash price of just 26. 

Apologies for going off on a tangent, but sharp changes in long-rates do matter. 

As BofA analysts said last week, “Yet, a rates shock at the long end of the curve is a more daunting affair for markets than the front-end tantrums witnessed thus far. Why? Issuers fund capex, secular growth opportunities, and net zero transition spending with longer-dated bond deals. A less deep bond market at the long end could see firms downsize their debt-funded investment ambitions, curtailing secular growth stories for some sectors.”

And as we’ve pointed out in recent weeks, rises in real yields matter. BofA points out that “higher real yields represent a much purer form of financial conditions tightening. And for a Euro Area economy that experienced sluggish post-Covid growth and a massive terms-of-trade shock last year, the risk of something else breaking in this cycle seems higher again.”

On the eurozone periphery, it's not the same names on the outside. France OATs are trading historically wide at 65bps to Bunds, but Italian BTPs while widening, are still far from their widest point. And the UK 10-year is trading at a higher yield than Greece! 

So, which risk assets have traditionally suffered from changes in long-dated real yields?

BofA has the answers, some are relatively obvious, Financials and Hybrids (especially HY) are much longer duration and will suffer from non-call risk, but it might be surprising for some to see, that IG and single-A credits are more at risk than single and double-Bs.

NB this might explain the sharp divergence of CCC and single-B names in EHY this year — it might not just be the disastrous recoveries for 2023 vintage defaults. 

In my old job as CEEMEA editor, I was fascinated by the world of International Arbitration. 

In particular how large awards against companies for non-performance of large contracts (and against governments for expropriation). 

It has been a lucrative sector for some investors and litigation funders such as Burford Capital, which has decided to either take on these cases or buy the awards at an appropriate discount (many of these processes take years, with appeals a plenty, and enforcing isn’t always easy).

Often there were claims and awards in the billions, which were non-public to investors in their bonds — despite often being enough to jeopardise their solvency — albeit with the ability to push out the day of reckoning into the distant future. 

There is some read-across here to the litigation claims against corporates, huge open-ended liabilities, such as asbestos claims whose legal cases and class actions have lasted for decades. 

But as we’ve seen in the US in the past couple of years, clever lawyers found a solution, by using the US Chapter 11 process to compromise these claims. The most high profile cases have been Purdue Pharma — currently going to the Supreme Court, and Johnson & Johnson, whose efforts to offload contaminated talcum powder liabilities into a subsidiary and do a Texas Two Step, were thwarted by Judge Michael Kaplan who famously said: “In sum, this Court smells smoke, but does not see the fire.”

Similar to Creditor and Creditor violence, none of these distasteful shenanigans had crossed the Atlantic to our knowledge until very recently, as 9fin revealed yesterday with McDermott International.

The US-based energy services firm, which was taken over by creditors in a US Chapter 11 in 2020 is seeking approval from courts in England and the Netherlands to extend the maturities of its debt facilities and to effectively wipe out $1.7bn in arbitral awards and administrative fines. 

Its UK subsidiary CB&I UK Limited is proposing a UK Restructuring Plan and parallel Dutch WHOA proceedings. It says that absent a maturity extension of the relevant debt facilities — it will be required to post cash collateral for roughly $2bn in Letters of Credit facilities on 27 March 2024, which it will be unable to do. McDermott’s board is of the view that a failure to implement the restructuring would most likely result in the need to commence insolvency proceedings in the relevant jurisdictions.

McDermott hopes to use the restructuring processes to duck a $1bn arbitral award against it, granted to Refineria de Cartagena by the ICC in June 2023. It is seeking to use the votes from secured creditors to cram down the unsecured arbitration award.

The award stems relates to the Reficar refinery project in Colombia, completed by McDermott in 2015. Colombian administrative authority Contraloria General de la Republica started an investigation in 2017 over improper cost overruns during the construction and modernisation of Reficar, resulting in a further $718m claim against McDermott in 2021, according to the PSL.

McDermott continues to challenge these claims in various legal forums. However, under the restructuring, it has proposed compromising the $1.7bn in claims, treated as unsecured, by wiping them out in exchange for performance-linked instruments paying a maximum of $4m.

Reficar’s owner, Ecopetrol, published a statement condemning McDermott’s proposals and filed a motion in the US on 25 September for a pre-judgment attachment over all the US property of CB&I UK and another McDermott subsidiary. It has indicated it will object to the UK RP. 

I won’t get into the legal arguments and the terms of the restructuring — our piece and the follow-ups are the place to go for this — but the case is likely to be closely watched by others, as to the art of the possible, using the new European tools to get rid of claims or costs arising from litigation claims and awards. 

We expect the challenge to be based on valuation issues, whether the relevant alternative is really administration and insolvency, and why unsecured creditors be compromised if the shareholders aren’t (echoes here of Adler. Remember there is no absolute priority rule in the UK). 

As one source close to the situation told 9fin, McDermott has $3bn of assets and is still to arrange DIP financing in the US, which could potentially be a source of funds to cover the arbitration claims. 

Why didn’t it go down the more tried and tested Chapter 11 route? We were told it couldn’t afford the cost. 

While my colleagues were beavering away looking through the McDermott filings on Wednesday, I was having a very pleasant lunch with a hedge fund manager in Mayfair, where the name came in conversation. They weren’t involved, but noted that one of the main issues for such companies was problems in obtaining letters of credit and bonding (guarantee lines). 

Energy services businesses are capital intensive and each new project requires letters of credit or performance bonds to support the performance obligations under a project contract.

For those less aware of trade finance, letters of credit can be redeemed on demand if there is no payment by the buyer on the date specified under the contract. Bank guarantees can be seen as an insurance contract and can be structured either as performance guarantees, against failure to perform an agreed contract, or warranty bonds, that the goods or services supplied will perform as per the contract under the specified warranty terms. If they do not, the Guarantee can be called on by the beneficiary.

But banks are no longer willing to provide performance bonds and letters of credit at such low rates — in a ZIRP environment, they were happy to earn 2% of total contract value — but with interest rates at current levels this no longer makes sense, my lunch companion explained. 

In addition, it was extremely rare they were ever called upon, but a couple of recent instances in the Middle East where performance bonds upon has meant that banks are upping their risk weightings and withdrawing, or not renewing their lines, he added. 

Going back to McDermott, in its court filings it notes that having significant exposure to letters of credit puts it in a very vulnerable position as a single draw on a LoC could encourage others to do the same, triggering a ‘run on the bank’ scenario. 

So, are there any other LevFin issuers which might suffer from similar issues? 

My lunch colleague said Saipem had flagged up the increased costs in a recent call, but given its recent turnaround and quasi-Italian government backing (the state fund CDP underwrote its 2022 capital increase), it should be fine. 

However, he highlighted Petrofac as potentially more vulnerable. 

The London-listed energy services firm has certainly had a troubled past, having to raise capital via equity and a HY bond in late 2021 after the UK courts imposed a $105m fine on the company relating to historic bribery offences. The price of the 2026 SSNs fell to the mid-50s when Petrofac warned of FY 22 losses in its December 2022 trading update.

But the bond price rocketed up 20 points, to 75 cents, in late March after the company announced it had won, alongside Hitachi, contracts worth some €13bn from the Dutch state-owned electricity company TenneT to develop offshore wind in the North Sea.

There was further good news when it agreed in principle to the extension of its bank debt in April. But counterbalancing this was a poor performance in the first half of 2023. Petrofac may only be EBITDA breakeven for FY23 after write-downs for one-offs, no margin recognition on some onerous legacy contracts and higher than expected overheads. It claimed good progress in resolving contractual disputes which should release working capital in the second half. 

But its pipeline is substantial, with over $5bn of backlog. 

It is worth noting that distressed companies often fall over not when they are preserving cash awaiting an uptick, but when they are trying to ramp up activity and are not able to fund the capex. The key question for Petrofac is whether it is able to fulfil these substantial contracts by continuing to secure available trade finance at reasonable terms, and bake-in enough profit this time around for cost inflation and overruns. 

Its 2026 SSNs remain in the mid-70s, to yield around 21%, a level which warrants (pun intended) further investigation by the 9fin team. 

A slew of updates this week for names in our Restructuring Tracker, most were relatively minor, however, and are dealt with briefly below. 

The exception was Lecta, the Spanish paper group which announced its proposed refinancing, which sees €75m of new super-senior money provided by shareholders (former creditors under a past restructuring) and current creditors, and an extension of maturities to 2028. A Restructuring QT analysing the transaction in greater detail is due shortly. 

Tele Columbus, the troubled German broadband fibre operator announced that it has received binding commitments for another €100m of capital, in addition to the €15m shareholder loan in July and €75m provided at the end of last year. This provided a minor boost to its €650m May 2025 SSNs which rose a few points into the mid-50s, but our house view remains that this is just to fund the business into a restructuring. 

Earlier this week, 9fin’s Bianca Boorer revealed that Demire bondholders had picked Hengeler Mueller and Houlihan Lokey as legal and financial advisors, amid doubts that it will be able to raise enough funds via asset sales and secured debt financing to repay its October 2024 bonds. For more detail on our situation, see Hazik Siddiqui’s prediction piece.

On Bianca Boorer’s recent trip to Germany, Alloheim, the German care home group was near the top of financial and legal advisor watchlists. A €5m piece of the Feb 2025 TLB traded with a cover of 86.56 she reveals with lenders concerned that an A&E is unlikely. 

Most of my time this week was spent reading through legal docs, and editing some excellent content by the 9finteam. 

NAV lending is taking up a lot of column inches of late, but rarely do journalists drill into the mechanics and the implications. Ted Seides NAV Loans: Canary or the Gold Mine (great title) therefore is a must read. 

As we continue to assess the bloodbath in European Real Estate, Bloomberg reveals that the ECB is concerned that banks are not fully writing down their exposures. 

My colleague Owen Sanderson spent time this week going through Dignity Finance documents and presentations. As he explains in this week’s Excess Spread the sponsors to the funeral home operator have used equity cures to keep their securitisation holders happy while securing more flexibility to sell funeral homes from the group. They claim that their closest peer is holiday park operator Center Parcs, where you park kids, rather than where you park the deceased. 

As Apollo is rumoured to be taking a look at X (formerly known as Twitter), its cash flow generation hopes are rightly trashed by a HY investor…

Caveat that this is just a patent, but Ford wants to be able to shut down your air conditioner and radio if you miss a car payment — and the car could even drive away on its own — H/T Mike Beadle.

At one point last Sunday at the Amex it looked like a repeat of the horror show at Villa the previous weekend conceding two goals in less than five minutes, both by giving the ball away in dangerous areas. But a strong second half comeback saw us draw 2-2. After the game Alexis Mac Allister, former Brighton player and World Cup winner, stayed out on the pitch to a standing ovation. One of the greatest players to play for the Albion and a true gent.

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