Rates have also moved sharply, UK 10 year yields are below 3% (remember when they hit 4.5% after the ‘mini-budget’?), and German 10 year yields are just 1.84% from 2.5% a month ago.

As Jim Reid from Deutsche Bank outlined on Thursday:

“...the latest FOMC minutes saw investors dial back the amount of rate hikes they’re expecting from the Fed over the months ahead. It may seem paradoxical that weak data is being treated as good news by markets, but in large part it’s because the focus is now so heavily on above-target inflation, which has prompted the most aggressive cycle of rate hikes in decades. So signs of slower growth are seen as bringing fewer inflation pressures and hence fewer rate hikes. On top of that, since a US and eurozone recession is now the consensus expectation among economists (and leading indicators are increasingly pointing that way too), contractionary data isn’t as likely to be as surprising to markets as it normally is.”

Risk is back on in Europe, and the value gap between EHY and US HY has closed markedly in recent weeks.

But are risk markets pricing in recession risks? What are the appropriate assumptions?

Many argue that the maturity wall is slight, reducing expectations of defaults in 2023 and 2024. Looking at credit spreads and default rates in past recessions, Deutsche suggests that while longer maturity walls do indeed reduce defaults, higher leverage is twice as important in determining the outcomes.

Deutsche says that high debt to sales ratios will expose very high leverage when profit margins inevitably compress, leading to distressed exchanges and missed interest payments.

“This fact (plus a lower-rated loan market) is why we believe US loan default rates will peak at 11.3% in the 2H'24, near all-time highs,” caution the bank’s research team.

Luckily, European leverage, while elevated, has not seen the rapid increase experienced in US credit markets, while the euro-denominated HY bond market has a higher credit rating than its dollar HY counterparts, notes DB.

But as the chart below outlines, European leveraged loan leverage is higher than its US counterpart and almost at pre-GFC heights.

The proliferation of single-B loans in leveraged loans and shorter maturity walls could lead to significant downgrade risk and overflowing CCC buckets for CLOs (most can have 7.5%), potentially impairing over-collateralisation tests, cautions DB, which estimates buckets could overflow to 13-15%.

Put all this together, and Deutsche are forecasting significantly higher spreads and default rates than implied by current prices:

If DB are anywhere near right for 2023, let’s give thanks for our November 2022 mark-to-markets.

Despite the surge in secondary prices, the EHY Primary market remains subdued. Liability management is the instrument of choice.

A month ago we predicted that a raft of A&E requests would hit the market, with one fund manager suggesting 10-15 deals could land before the end of the first quarter. After the Ketter kerfuffle that pace might slow, until the right pricing and deal structures can be found.

This week, the NewDay exchange offer shows that borrowers must still pay up massively to get deals done. The exchange offer proposes 13.25% for SSN paper — although as 9fin’s Owen Sanderson suggests, they’re arguably SSINO (senior secured in name only) given the presence of over £2bn of securitised debt ahead of them. Another interesting price point reference is the junior tranche of its latest securitisation (albeit retained) which paid Sonia+1050 bps — perhaps the new deal isn’t so cheap after all? On Thursday, the cash payment on offer for the exchange leapt from 18 to 31 points.

Risky and Revolver

While the maturity wall is light for 2023 and early 2024, it’s closer than you think if you include the accompanying revolvers that mature six-to-twelve months before bond/loan maturities.

In the current market, banks are less keen to provide RCFs, making an extension less than certain (clearly borrowers will need to pay up) but conversely they don’t want to create liquidity issues for their sponsor clients.

With refinancing looking uncertain for many deals in the current climate, it is more difficult to deal with your debt holistically. One solution is to extend your RCF beyond other maturities with a springing maturity if the other debt is not refinanced, say 3-6 months before they are due.

RCFs in a covenant-lite world are the last bastion of incurrence covenants. Many have a springing leverage covenant, typically limiting further draws if around 40% (most typical) of the facility size is drawn and leverage hits a certain level. This in theory gives lead banks a disproportionate amount of power, but in practice docs are watered down to the point that they rarely come into play, or do so far too late.

Unlike immediately post-GFC, we’ve seen few RCFs trade out into hedge fund hands, making extension negotiations easier.

We are unlikely to see many companies held to ransom, as was the case with Tele Columbus, in 2010, with one hedge fund petitioning for insolvency over a small double-digit sum. As the CFO told me in a Fireside Chat at an event — he was summoned to a meeting with the fund and an insolvency administrator to discuss the payout. He said if he’d known what it was about, he’d have brought his chequebook — the company had more than €50m in the bank at the time!

The use of RCFs was a keen topic of conversation in earnings calls this week.

It used to be Restructuring 101 for businesses, draw down as much of your RCF as you can in times of stress or anticipated stress to give you a buffer and draw your banks into the negotiations. But of late companies have been surprisingly reticent to do so, relying on other sources of funding such as ABLs, and in the case of Vallourec, using them to replace your RCF on cost grounds.

But sometimes the reticence to avoid utilising your RCF can be taken to extremes.

Wepa this week revealed a cash balance of just €7m on 1 September. It had over €48m of (reduced) revolver availability after drawing down €27.5m during Q3 to mitigate the effects of a cyber attack. Q4 is expected to be much better, but even if it beats their standout second quarter, repaying the RCF as intended would barely improve the cash position.

The Germany-based manufacturer and supplier of tissue products had said in the previous quarter that it would not need to renegotiate the RCF, but in Q3 the springing covenant level was increased to 6.5x from 5.75x.

Despite paper thin liquidity, mostly due to high working capital needs (30% of sales), management said that their intention was to repay the RCF balance in Q4. The working capital burden comes straight from the broader macro environment — the idea is to increase inventories to insulate from the effects of a possible gas embargo. 

One analyst on Wednesday’s call questioned the wisdom in doing so. Even if the company hits €40m in EBITDA in the fourth quarter, with around €13m of Capex and €27.3m of RCF repayment plus €9m of interest, its cash balance would diminish further. They suggested Wepa would therefore need to look at other lines of funding.

There was some confusion over the presence of a previous subordinated money market line (it was not shown in the Q3 reporting) and whether it was committed by relationship banks. Management said the facility was still there and it is rolling, with its size now €20m (from €25m) but the rates available were not as attractive as previously. With a hefty receivables facility close to the max (€183.2m drawn versus €220m) why not utilise the cheap RCF to provide a buffer?

Very unwell?

But fully drawing down your revolver can spook investors, as was the case in Very Group’s call on Thursday (24 November). During Q1 23 it fully drew upon its £150m RCF, as 9fin’s Lara Gibson reported. One analyst bluntly summarised the situation: “Obviously, you're fully drawing on your RCF and your cash balance is looking a bit low”.

CFO Ben Fletcher attempted to ease investor concerns by insisting “RCF drawings tend to peak at the end of the first quarter and at the end of the third quarter. I'm expecting that profile this year.” However, he declined to confirm if Very Group would be in a position to pay off the RCF at the end of Q2 as it has done in past years.

Over-indebtedness has been a key concern for Very’s performance in recent years. Latest net leverage clocks in at a modest 2.43x, however this calculation does not include the drawn £1.418bn securitisation facility, which dwarfs the retailer’s £575m 2026 SSNs and £150m RCF.

If Very Group were to include the securitisation facility, net debt would amount to £1.999bn and net leverage to 8.35x, based on the LTM consolidated EBITDA of £239.4m. Several investors bemoaned about Very Group’s onerous securitisation interest payments, which are expected to rise in the following year as a result of “wider market patterns” which we assume is during to recent spread widening within securitisation markets and rises in Sonia.

A source close to the management told 9fin that the group is considering alternative options to de-lever the business. “The current capital structure is too unsustainable and nearly all financial decisions have to be based around how they can pay interest, rather than how they can develop business,” they added.

Mail Order buyers can pick up the SSNs at 15.75% yield.

Voyage Care is another business that it likely to draw heavily on its revolver in the coming months. The UK care home operator is struggling to push through fee increases amid social services budget cuts and unfavourable shifts in its revenue mix, noted 9fin’s Denitsa Stoyanova who listened into Thursday’s earnings call.

It is suffering hard from inflationary pressures with wage inflation of 6.6% and difficulties in hiring care workers, increasing its reliance on expensive agency staff. Opex inflation is 10%, well above 5.5% fee growth. Leverage has increased half a turn since the launch of its bond earlier this year to 5.5x.

FCF has turned negative, leaving just £18m of liquidity, depleted by bolt-on acquisitions. It has £45m available on its £50m revolver, which is, unusually, based on a EBITDA test of £26.1m. There’s plenty of headroom on the test based on a Q3 LTM figure of £45m, and the business is on the look-out for good investment opportunities to be funded by the Super Senior RCF. This would prime the 2027 SSNs by over a turn, but with care homes valued around 9-10x there is a decent cushion, plus good asset coverage, as it owns most of its homes (property portfolio valued at £436m). The bonds, issued at 5.875% in February, have recently crept above 10%.

Corestate of Lux

We expected further shenanigans at Corestate this week and we were not disappointed. The battle of wills with bondholders was expected to go down to the wire, with its shareholder proposal and bonds counterproposal voted upon at a creditors meeting on 28 November, the same date as the maturity of its €200m converts. The company had also proposed a short extension of the converts to April 2023, to match the maturity of its €300m SUNs.

Late last Friday, the company said that it had “come to the conclusion tonight that in the management board’s view it is no longer sufficiently likely that the restructuring negotiations conducted with major noteholders will be concluded successfully. As a result, the convertible bond is expected to become due and payable on November 28, 2022. In light of this situation, the management board will review whether CCHSA is under an obligation to file for insolvency.”

This raised the prospect of Luxembourg insolvency, described as ‘messy’ by one restructuring advisor to 9fin, and a ‘nightmare’ by another. The small principality has not yet embraced the EU’s creditor-friendly minimum standards guidelines.

I frantically started to read lawyer notes and started to prepare a Luxembourg primer to accompany our editorial update. The timing became more urgent when the bondholder side told my colleague Bianca Boorer they were adamant that they would stick to their proposal, despite the threat of imminent insolvency.

The company side explained that the ad hoc bondholder group had proposed some amendments to its proposal outlined in the prior cleansing statement. This caused a furore amongst the shareholders and caused the talks to breakdown on Friday.

But as we prepped our article on Tuesday morning, there was a surprising twist.

The German real estate operator appeared to blink first, saying that its board had decided to unanimously support the group’s bondholder ad hoc committee (AHC)’s restructuring proposal despite opposition from its equity investors.

“The main reason for the decision is to secure the going concern of the company in view of the remaining time until the creditors’ meeting on 28 November 2022 and in light of the talks between the investor group and the AHC, which have so far been inconclusive,” the company said.

“Together with the representatives of the bondholders, the AHC proposal is now to be further elaborated in the short term, including a necessary bridge financing, and brought into an implementable, legally binding form on the basis of which the going concern of the Group is ensured.”

The extraordinary general meeting (EGM) which was set to happen on Friday (November 25) has been rescheduled to 20 December in order “to enable a broad shareholder vote with the help of a concrete restructuring concept that promises success”.

To recap, the AHC proposal involves taking over 81.25% of the group’s equity in return for a 80% haircut. Bondholders will provide €25m of fresh money through new super senior notes to plug an expected liquidity gap.

TLDR of Luxembourg insolvency (thanks to DLA Piper):

Under article 437 of the Luxembourg Code of Commerce, a commercial entity is bankrupt when it has ceased its payments; and its credit is exhausted. Both conditions must be met on the day of the bankruptcy adjudication by the commercial court.

The directors of a bankrupt commercial company must file for bankruptcy within one month from the cessation of payments.

Failure to file for bankruptcy may constitute the criminal offence of simple bankruptcy. The sanctions for this offence range between one month and two years of imprisonment.

There is no concept of a duty of the directors towards third parties. Upon the opening of the bankruptcy proceedings, the management of the company is entrusted to a bankruptcy receiver who typically realises value from liquidation sales of assets.

Creditors’ interests are taken into account only indirectly when assessing the existence of any failures in management which have contributed to the bankruptcy.

Once filed, there is a stay on enforcement for unsecured creditors.

Orpea call to alms

As the Workout hits your inboxes, Orpea unsecured bondholders are hosting a call at 2:30 pm CET (1:30 GMT) to discuss the details of the company’s transformation plan. The call is less than a week before Orpea’s unsecured creditors are due to meet the formidable Hélène Bourbouloux, the conciliator appointed by the court, to negotiate a settlement.

As we bemoaned in last week’s Workout, there is a lot of hubbub following the hullabaloo at the transformation plan release, especially with regards to the valuation of the restructured business.

Despite all the brouhaha from the company, we understand that the equity splits between those providing new money and the debt/equity swap yet to be decided, and senior secured lenders are yet to come onside. We would add that further hits to real estate values are likely by year-end and the timeline to get binding commitments for €1.2bn to €1.5bn of fresh equity is very tight.

Our analysis piece, hot of the press this afternoon, is available here

Thinking Strategically

The Workout has been critical of Elior in the past, openly expressing its befuddlement how the France-based catering and facilities manager could get a HY bond away in July 2021 at 3.75% based on 2019 numbers (9.5x levered based on FY 20 figs).

We said last November: “It is suffering from cost inflation pressures and is trying to pass these on, but over 40% of contracts are on an annual basis, and in a traditionally low-margin business, failure to do impacts the bottom line. Add in uncertainty with regards to hybrid working and changing patterns of work, it may never get back to 2019 levels.”

Fast forward a year, and Elior only broke even at EBIT level for the current fiscal year (after stripping out its Preferred Meals business which it closed in July) and is only projecting 1.5%-2% EBIT margins for next year on organic revenue growth of 8%. It’s clearly unable to meet its 4.5x leverage covenant on 30 September 2023 with little capacity to generate free cash flow in 2023.

Elior is projecting Adjusted EBITA margins of around 4% in 2024 (above its pre-Covid level) and hopes to restart dividends to its beleaguered shareholders that same year. The shareholder register includes Derichebourg with a 24.5% stake. The shares are down 59% YTD, leaving a €427m market cap. Our paper short on bonds has worked out well, they now yield 13.25%.

In its conference call on Weds, management said that it will soon complete its review of strategic options, including addressing the balance sheet. It said the “Board of Directors is finalising examining various scenarios with the aim to retain the one that will optimise the Group’s strategic orientations and improve its financial position.”

Several questions centred around the contents of the review, which CEO Bernard Gault said would be unveiled to investors in a few weeks and would include measures to address the balance sheet and strengthen the company’s strategic position. He said there are synergies to extract, and the group needs greater flexibility to take advantage of opportunities going forward.

Gault said he would not be drawn on whether the plan would include further disposals, strategic joint-ventures or a capital increase. But he said it would “absolutely not” include a Conciliation and Sauvegarde process with creditors.

A Bloomberg article a day later, however, forced the company’s hand. The piece said that Elior was weighing a tie-up with Derichebourg, whose shares were suspended the next morning pending an announcement. In a press release Elior said that one option relates to the potential contribution by Derichebourg of its services division (around 30% of revenue).

It’s too early to assess the impacts. We expect that Derichebourg would be keen to avoid a change of control trigger and would structure a deal accordingly. In the meantime, time to cover our short.

What we are reading this week

From my emerging market reporting days, I’ve always had an interest in international arbitration, one of the best ways to secure claims over assets from recalcitrant borrowers in difficult jurisdictions.

The Law Commission has launched a review to “maintain the attractiveness of England and Wales as an arbitral seat and to preserve the 'pre-eminence of English Law as a choice of law.” Wilkie Farr have produced an excellent year in review, which can be accessed here

I also listened into an excellent briefing by Allen & Overy on enforcement strategies for borrowers who can’t pay, won’t pay, looking at the pros/cons of bankruptcy applications from creditors versus litigation strategies. Copies of their slides are available on request.

With banks stuck with LBO paper going into year end and markets remaining difficult we hear that some strategies post GFC are coming back. We hear that Total Return Swap with leverage could be back on offer from banks, and Ashurst asks if Forward Start Facilities are back on the horizon again?

Stock Buybacks have distorted equity markets in recent years but as Ben Hunt from Epsilon Theory says : “If they’re not going to give me MY money back directly in the form of a dividend (on which I have to pay taxes, so ugh, but okay), then the least harm they can do is buy back shares and shrink the share count.”

But he adds that there has been a sea change in the past decade in their size and scope:

”I believe that there has been a truly astronomical transfer of wealth – well more than a trillion dollars – over the past 10 years from shareholders of publicly traded companies to managers of publicly traded companies. Not founders, not entrepreneurs, not risk-takers … managers.”

A rare victory for human rights in Qatar:

And in London, the Tube map gets an important upgrade:

As the Festive Season fast approaches, NewsThump reveals that a six year-old who still believes in Santa is old enough to know the ‘Brexit dividend’ isn’t real