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Private Credit 

Chris Haffenden

Warren Buffett famously said in 2017: “What you find is there’s never just one cockroach in the kitchen when you start looking around.” 

His remarks were about the banking system. When the spotlight is put on one, you are likely to see plenty more roaches crawling around the floor. After SVB and Signature Bank, it was Credit Suisse and First Republic Bank. 

In the end, it is all about confidence in your counterparties. The capital and liquidity numbers are backward looking and at a late stage when everyone is spooked and withdrawing deposits, they rarely matter. 

Prior to its forced rescue last weekend, Debit Suisse had given a presentation stating that its common equity tier one capital ratio was 14%, with tier one capital at 20% (the difference being the the $17bn of AT1 bonds that would be wiped out). Book value was CHF 35bn.

But as one letter to the FT remarked, even Lehman Brothers had perfect capital ratios a day before filing for bankruptcy!

One financial advisor at a private debt event I was moderating this week said that they had a signing last week (just post SVB and prior to CS) and just the day before, they were given a list of 13 banks (including SVB and CS). The request required a confirmation they didn’t have any banking relationships with any of the bakers’ dozen. 

Funds tell me that in recent days they have been bombarded with requests from nervous investors asking about their counterparty exposures. 

So, counterparty risk is back on the agenda. This is probably why windows from Central Banks were opened at the weekend for dollar liquidity, meaning that banks are readily able to source funds away from their peers and not worry about who they are dealing with. 

It’s too early to say if this bank run on confidence has been contained by the central banks’ swift action, which central bankers are keen (perhaps too keen) to say aren’t bailouts. But I think it is reasonable to expect that certain pockets such as challenger banks in the UK, and some types of lending such as ARR and NAV loans could become more constrained. 

There is also the wider effects of the failures of names such as SVB (big ARR loan provider) and Signature Bank — a capital call lender for a number of private debt funds. 

My personal view is that there is unlikely to be systemic risk, but it will lead to further bank consolidation and further regulation (particularly needed in the US outside the systemically important institutions). 

As the details of the shotgun wedding between UBS and CS broke on Monday morning, there was outrage over the toasting of the AT1 bonds while the shareholders got SFR 3bn. Why isn’t the normal waterfall being respected? This could spell the end of the AT1 market, investors suggested on Monday morning, as the prices of other AT1 paper tanked. The Invesco AT1 ETF fell by 14%. 

Some longstanding CoCo detractors pointed out that if you read the docs, in addition to the 7% hurdle, the CS AT1s (not CoCos really, as they don’t convert) could be written down in a ‘liability event’ which could be defined if the bank has received “an irrevocable commitment of extraordinary support from the public sector.”

The bonds were certainly supposed to bear losses, but what about the equity? There’s the slide above, but the risk factors said: "Furthermore, in the case of any such cancellation, FINMA may not be required to follow any order of priority, which means, among other things, that the Notes could be cancelled in whole or in part prior to the cancellation of any or all of CSG's equity capital.”

(h/t to FT Alphaville for the below, go here to buy the T-shirt)

But why did UBS pay more than just a nominal CHF 1 for the bank? 

After wiping out $17bn of contingent capital, securing a hefty guarantee to insure against litigation risks and with the SNB providing a loan of CHF 100bn (and another 100bn as a backstop if needed), there’s arguably a decent amount of equity value. But we don’t know (and might not fully know for some time) just how bad the illiquid assets and exposures on CS’ balance sheet were. 

Other central banks and regulators were quick to try and reassure the markets that they wouldn’t follow the precedent set by the Swiss. The EBA and ECB issued a joint statement saying that under the resolution framework equity holders should be the first to absorb losses and AT1 bonds only written off after all common equity tier 1 (CET 1) has been exhausted. 

This provided some relief to other AT1 prices and while the flight to quality continued with government bond yields falling sharply, prices of other risk assets were contained ahead of the Fed and Bank of England rates decisions. 

Prices of Credit Suisse AT1 paper started to rise from the low-to-mid single digits on Monday (20 March) to the mid-to-high single digits on Wednesday, as some distressed investors sought to buy into the bonds to pursue litigation strategies.

As 9fin’s David Orbay-Graves wrote on Wednesday(accessible to 9fin clients), in a widely circulated piece of credit research, analysts at JPMorgan weighed in, highlighting apparent inconsistencies between Swiss regulator FINMA’s rationale for the bail-in and the terms under the bond documents:

“In terms of challenging their bail-in, Credit Suisse AT1 holders are likely to query how FINMA could deem the bank at risk of bankruptcy if there was still CHF 3bn equity value, said the second buysider. FINMA would need to argue there was no ‘alternative’, while bondholders may argue that not all options were explored, such as AT1 holders contributing capital or purchasing assets to restore liquidity.

But, at the same time as brokering the takeover of Credit Suisse, the Swiss authorities raced through a change in the law, allowing the regulator to order the bail-in of AT1 securities when granting emergency liquidity. At least for the AT1 bond documentation seen by 9fin, the notes are governed by Swiss law and the forum for dispute resolution is listed as the Zurich courts.

Although not bound by the EU’s Bank Recovery & Resolution framework, Switzerland’s legislation appears to feature similar No Creditor Worse Off (NCWO) provisions, stipulating that bailed-in creditors should not be left worse off through a bank resolution than if the bank were liquidated.”

But in an excellent piece, Matt Levine suggests that the deal might stop short of bank resolution. 

Whatever your view, it appears that this is getting litigated, with Quinn Emanuel hosting a call for investors on Weds, identifying four potential avenues for recoveries:

1) litigating against Credit Suisse itself in the Swiss courts on grounds of misrepresentation; 

2) litigating against the government or FINMA in the Swiss courts on grounds of expropriation; 

3) pursuing a claim under a relevant Bilateral Investment Treaty; or 

4) making a claim in a foreign jurisdiction court if certain thresholds are met (for example the US where Credit Suisse was registered with the SEC).

With all this uncertainty and market volatility, what would/should central banks do? 

Some observers thought the right thing to do was to pause, and wait to see what other effects come to light after the sharp rise in interest rates in the past six months. One house was even brave enough to predict a 25 bps cut. 

If central banks pause, would that signal that perhaps the underlying situation is worse than many thought? 

But if they continued to raise aggressively, could this cause more things to break?

Given all the potential head fakery above, the words accompanying the FOMC move were arguably more important than in past meetings. Taking the strain off monetary policy, some hoped that more measures could be announced such as a raising of the FDIC insurance cap. 

So as we sat down for dinner on Wednesday, we were all hanging on Powell’s words.

In his statement Jerome Powell said that the US banking system is sound and that the Fed programmes are “effectively meeting” liquidity needs while policymakers are closely monitoring the situation.

Events in the past week are likely to weigh on lending standards and slow the economy, which might mean fewer rate hikes than previously thought. Powell said some officials had considered a pause, but unanimously voted to hike rates (by 25 bps).

The word “pause” caused a rally in the front end of US Treasuries. But risk assets were less impressed, after Treasury Secretary Yellen said “I have not considered or discussed anything having to do with blanket insurance or guarantees of deposits.” 

She added it was not yet the time to discuss changing the FDIC insurance cap.

At time of writing some stability has returned to European LevFin. The iTraxx Crossover closed on Weds at 470 bps with secondary EHY prices opening up 0.25-0.5 post FOMC on Thursday am. Primary has reopened too, with more deals slated for next week, as Ineos Enterprises’ postponed loan deal (accessible to 9fin clients) on Monday becomes a faded memory. 

The Bank of England as expected raised rates by 25 bps on Thursday, but sounded much more dovish on inflation, which could mean that terminal rates might not go too much higher from here — I admit to being skewed here, as I might be taking out a mortgage in the next quarter. 

After all the events of the past two weeks, a period of calm would be a relief. But are Treasury yields right to settle here? 2yr at 3.9% (from 5.09% on 9 March) and 10yr at 3.47% (4.07% on 3 March). The Fed’s dot plot suggests that rates would still be 4.3% by the end of 2024. A week ago, there was the expectation of 100 bps of rate cuts by the end of this year (sub 4%), and according to Deutsche Bank 60 bps is still being priced in. The expectations of the Fed governors and the market (as implied by prices) remain very divergent, although I readily admit though a lot of the latest move has been driven by flows into safe assets not interest rate views per se. 

After weeks of deliberations, the credit derivative determinations committee finally reached a decision on a request on Vue, with 9fin cited as a data reference point, our first (and surely not the last) reference in a CDS determination ruling. 

To recap, the original Vue CDS question —  whether a restructuring credit event had occurred —was submitted way back on 2 February — with a second request whether there is a successor to Vue International Bidco Plc, submitted on 27 February. 

As reported, the UK cinema group’s recapitalisation (accessible to 9fin clients) closed on 26 January, including a debt/equity swap and extinguishment of the second lien with new debt being issued from Vue Entertainment Intl Ltd, a newly incorporated entity. 

The main problem in making a determination was the public/private issue, as the public CDS were previously referenced against bonds before they were refinanced by term loans.

Those involved in the Vue restructuring told us they have received numerous requests to provide additional info, but the company has no obligation to do so. The amount of outstanding CDS is small, was bought cheaply and could be argued it was a long shot from those that did. Plus there is plenty of pressure from the other side of the CDS trade placed on stakeholders not to engage.

On Wednesday, after a number of meetings, they decided that a restructuring credit event had occurred (Citi was the only dissenting member). But no determination has been made on whether a bankruptcy credit event has occurred and the committee said it will continue to meet to consider this question. 

Last week in our analysis piece on Groupe Casino we said:

This is a bad time for Casino to underperform in terms of operations, cash flow generation and deleveraging, as the group faces a large maturity wall (€1.4bn in 2024 and €1.8bn in 2025) in France alone. The challenge becomes even more daunting when you consider that Casino is also on the hook for repaying the €1,992m of 2025 maturities sitting at its parent HoldCo, Rallye, which was restructured via a contentious Sauvegarde in 2019.

Casino must increase its cash balances and drive leverage low to be able to dividend up funds to meet Rallye obligations. Alternatively, it must offer a more compelling option than previous attempts to buy back its HoldCo Rallye unsecured debt at hefty discounts, that received a poor take-up from bondholders.

I’m not sure if the directors of Rallye were forwarded our report, but on Wednesday they said in another skinny annual results release:

Rallye has already gone back to the court once since its controversial Sauvegarde in 2019, to gain an extension, pushing a jumbo debt repayment out from February 2023 to February 2025.

It may be a tougher task to do so again, with the new amended Sauvegarde regime and its increased creditor rights (they were excluded in the original from voting). 

Hidden in Diebold’s 2023 annual report was the following section (bolding for emphasis): 

“As of December 31, 2022, therefore, the Company had no additional availability under the ABL Facility and $344 of cash, cash equivalents, restricted cash and short-term investments. As designed, the ABL Facility availability resets each month. Initially, the Company believed that the Refinancing Transactions, along with cash from operations, would be sufficient to meet the Company’s near-term and long-term liquidity needs for at least the next 12 months. 

Over the course of the first quarter of 2023, based on the Company’s revenue cycle and the composition of the borrowing base under the ABL Facility, the availability under the ABL Facility as of March 2023 has been substantially limited. In addition, slower-than expected conversion of inventory into revenue has further suppressed liquidity. Accordingly, without modifications to the ABL Facility and access to additional capital, the Company currently projects that it will not generate sufficient cash from operations or have access to other sources of liquidity to sustain its operating needs or to meet its obligations as they become due over the twelve-month period subsequent to the filing of this annual report on Form 10-K.”

It was only last November, that the ATM machine manufacturer had completed a soft restructuring with an A&E, new facilities and the replacement of its RCF with an ABL. 

Luckily, just days later on 21 March, it announced an amendment and limited waiver to the ABL agreement with a new $55m First In Last Out (FILO) tranche which matures on 4 June 2023. 

The company continues to try and take out the stub of its 2024 SUNs, with a deadline set for this Friday. If less than $52.1m exchange it must raise equity capital to repay them before maturity, and if it fails to raise more than $20m of equity it constitutes an event of default under the new super senior notes and exchanged SSNs and TLBs. 

9fin’s Emmet McNally will be taking a closer look on latest developments in the coming days. 

Ahead of its earnings report due next Monday, Emmet McNally has produced an update on Kloeckner Pentaplast the German packaging producer — arguably the most opportunistic of the stressed refinancings in 2021 — with the financing paying out a dividend to sponsor SVP. 

Our piece explores refinancing risk and suggest that expected improvements in 2023 and 2024 may not be enough to secure a refi for its 2026 maturities. 

It was adios for Amigo Loans this week, which finally called time on its new lending business (accessible to 9fin clients) after failing to secure enough new funding. This means that the fallback solution will be implemented. Amigo loans will stop lending with immediate effect and go into wind-down, which will last around 12 months. There is a call for shareholders at 12pm on Friday. 

The splinter group of Orpea unsecured noteholders continue to push for an alternative deal, issuing an amended term sheet earlier this week. But as Bianca Boorer writes (accessible to 9fin clients), they may need a positive outcome in their litigation challenging the validity of company’s lock-up agreement to gain traction. A Sauvegarde filing to implement the deal via a cram down is expected this week. 

A rare direct lending facility debt-for-equity swap was revealed last Friday, as UK-based consumer credit provider Non-Standard Finance Group (NSF) said a portion of its secured debt is set to be written-off in exchange for equity.

The secured debt being restructured was provided by a group of investors led by Alcentra. 

The news comes as private debt restructuring activity is picking up in Europe. A financial advisor away from the deal told 9fin that direct lenders have quietly conducted some smaller debt-for-equity swaps already, but that the NSF deal is notable for its size and for being publicly listed.

Talking of distress in private debt, I had the pleasure of chairing a roundtable with Mayer Brown earlier this week on the subject. A cracking discussion was had with Mark Wilton from Barings, William Allen from Marlborough Partners; Ian Sale from HSBC, Thierry Aoun from IK Partners, Zelf Hussain from PwC and Stuart Brinkworth from Mayer Brown. 

Thanks to all for their contributions, and thanks to Mayer Brown for the wine gifts. We are working on two reports from the event, to be published for 9fin subscribers in early April. 

A lot of our time early this week was spent looking through AT1 docs and reading FinTwit outrage on the CS debacle. Our own Owen Sanderson has the best obituary Suisse finished — how did a G-SIFI collapse?

No Eskom news this week, but instead a cracking substitution, Olivier Holmey’s coverage of a $11bn arbitration award against Nigeria. After reading the below, surely a must click?

Hedge fund seeking $11 billion from Nigeria admitted crimes in secret case | Semafor

Nigeria’s financial stability is on the line in a legal battle where its opponent is claiming payments allegedly made to secure a contract are — simultaneously — both legal and illegal.

I’ve always hated playing against a low block. Hindenberg Research’s latest target is Block Inc, a “frictionless” and “magical” financial technology with a mission to empower the “unbanked” and the “underbanked”. 

Brighton battered the haddocks last Sunday, beating Grimsby 5-0 in the FA Cup Quarterfinal, setting up a meeting with Manchester United (who they lost to in a replay in the 1983 final) at Wembley on 23 April. 

Thanks to the Grimsby fans for creating such as great atmosphere, with thousands of Harry the Haddocks on view, their support was incredible. And their mascot easily beat Gully in the half time entertainment race.

Changes in my Workout Programme: I’m off to the Canaries for a few days, before diving into the Adler Sanction hearing on 30/31 March, the next Workout will be on Thursday 6 April.

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