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Chris Haffenden

Last week I suggested that the Santa rally had come early this year and further gains might be limited. But Wednesday’s FOMC meeting produced further Xmas presents for investors with gifts of lower dot plots and dovish language. US 10-year yields dipped below 4% (3.92% close on Thursday), with a 25bps cut in March now rated a 100% certainty by analysts and 125bps of cuts in total forecast for 2024. 

Admittedly, despite the recent pivot from the higher for longer narrative, markets are still well ahead of the central bank officials in their rate cutting expectations. However, the table from ING below shows the extent of the dovish shift from Fed officials since September.

On Thursday morning ahead of the ECB decision, five-year Bund yields dipped below 2%, their lowest level for over a year, a hefty 90bps lower than we saw at the end of September. But the ECB didn’t follow the Fed’s cue; it pushed back against rate cutting expectations, saying there will be a plateau between the last increase and first cut. Five-year Bunds are at 2.08%. 

The bullishness in fixed income is setting us up for a strong primary January in European LevFin, and perhaps at least one stressed borrower might decide to try its luck next week. 

The positive sentiment has spilled over into the restructuring arena, with sponsors seemingly able to get away with smaller equity/cash injections, with creditors happy to PIK interest and extend their debt, in return for absence of haircuts, despite sizeable execution risk. 

HoldCo PIK, seen by many as a bull market instrument, is well and truly back in fashion. 

More on this later, but first, are investors positioned for the duration play for a soft-landing world? 

The short (duration) answer is, not well. 

Most investors in the past 18 months adopted a defensive stance, reducing their exposure to longer-duration assets. 

And it is not easy to pivot. After being starved of supply, the European HY market overall is of a much shorter-duration than historically. It might take some time to change, as borrowers are likely to be less keen to lock-in longer-term fixed if they think rates have further to drop.

The recent Synlab deal illustrated this clearly. 

A rare 7NC3 deal, rather than the usual 5NC2 fare, the Synlab SSNs came with IPTs at 8.25%, well inside the 8.75-9% fair value that 9fin analysts had predicted in their Credit QT. Price guidance drove in to 8% (+/- 1/8th) before pricing at an impressive 7.875%. 

But the bond component of the Germany-based lab business re-leveraging was downsized and the loans upsized, despite the all-in for the loans coming in around 8.75%.

My initial musings were that books for the bonds fell away when pricing dropped below 8%, but that doesn’t fit with the bonds opening up at 100.40 bid! 

Perhaps, another explanation is that the sponsor is keen to maintain flexibility (loans typically have shorter non-call periods — either six months or a year). The floating rate element reduces interest costs as rates fall, and you can refi or reprice with no penalty in 6-12 months. Whereas for a bond, you are looking at having to pay 50% of a heightened coupon to call.

We are investigating these dynamics further; let us know your thoughts in the meantime. 

Call protection at this point in the cycle is an interesting topic. As rates fall and spreads tighten, the price upside for current coupon paper will be capped by the presence of the call. But on the flip side, you have a much better running yield. 

As we’ve noted in the Top of the Flops series, lower coupon bonds have suffered badly in a rising rate environment, due to duration effects and positive convexity. There are a number of bonds at or below 90, giving the potential for greater pricing upside than new primary. 

A quick bond maths explainer: duration is the first derivative of a change in price for a change in yield — so, if you have a duration of four and yields increase by 100bps, all things being equal, the bond price drops by four points. Convexity is the second derivative (it is the change in duration for a change in yield). Convexity will be increasingly negative the more prices move about par, and more positive the lower the price falls below par. Historically Euro HY duration has ranged from 2.8 to a high of 4.1, and convexity from -0.4 to + 0.15. 

Another recent primary issue provided a good illustration of this convexity conundrum.

Iliad, the European TeleCo, already had a well defined bond curve for SSNs and SUNs. It guided its February 29 SUNs in the 5.5% area. At launch its existing 1.875% Feb 28s were indicated at around 90, to yield 4.5%, so investors could benefit from a hefty 100bps pick up for the new paper; a nice trade. 

The 5.625% February 2030 bonds were trading around 100.5 bid, bang on where the new one-year shorter paper was guided, with little convexity. On that basis there was arguably some new issue premium, say 25-50bps. 

However, countering this argument and use of simple straight line interpolation is that the lower coupon and sticker price Feb 28s offer much greater convexity — what price for this? 

The new bonds priced at 5.375%. We will keep an eye on this RV as events unfold. 

As my colleague Owen Sanderson would say, two’s a trend. 

In the space of a fortnight, we have had two soft restructurings in which PIK debt played a key part — Tele Columbus and Hurtigruten (NB: both have been pitched as recapitalisations, but we categorise as restructurings). 

The deals are different in their details and rationale, but have plenty of common elements. 

There is new money for both (from sponsor in Tele C and lenders in Hurtigruten), but in each case it is to fund the business, not delivering any deleveraging in return for a maturity extension. And arguably the conversion of interest to PIK is doing the heavy lifting by reducing the amount of new money required, which in both cases looks skinny. 

Reflecting the par lender and heavy CLO component in each, both were able to secure agreement without the sponsor giving up equity (or just a small amount of ‘synthetic equity’ in the latter) and/or control, despite significant execution risk. Is there an equal sharing of this risk? And while both are being touted as a par exchange — neither will trade there post restructuring. 

Tele Columbus got over the line with its lock-ups earlier this week on the 12 December deadline, but without unanimous consent from lenders, it will still need a single-class English Scheme and may need a German STARUG to amend the shareholder agreement, if JV partner United Internet doesn’t participate. (For more on Tele Columbus, see our analysis of the deal here). 

9fin subscribers would be well aware of our scepticism that Hurtigruten, the Norway-based cruise and expeditions operator, could deliver on its revised business plan. We were astounded how easily lenders agreed to an A&E in February, which 9fin’s Denitsa Stoyanova believed would only buy 1.5 years of runway and she questioned whether the €173m of liquidity was enough. 

Albacore, a frequent travel partner of sponsor TDR Capital, came onboard to smooth the deal in February. It put in €200m of new financing (to take out TLC/D tranches), which sat alongside the extended TLB (2027), but it carried a higher margin (albeit part-paid as PIK). The firm also subscribed to a minority equity stake via a warrants issue. 

But it wasn’t long before sponsor TDR had to drip feed in yet more shareholder loans, as its promises of positive FCF disappeared far over the horizon. Incredibly, in six of the last eight quarters since Q3 21, it injected €327m, mainly in the form of shareholder PIK loans to cover capex, interest and to plug the continued operational underperformance.

We added that the sponsor appeared to change course in Q2 23, with the latest €62m of financing being mainly asset-based lending. Denitsa wrote in late October:

“This suggests to us that the sponsor is aware that Hurtigruten is heading towards another round of restructuring, and have switched to asset-based lending to improve their recoveries.”

The ‘holistic recapitalisation’ announced on Tuesday, contains several information gaps, so we cannot full assess the plan, but I will try and outline the key components (from the presentation): 

There is €185m of net new liquidity (from interim funding, interest deferrals and exit financing), with cash pay debt reduced from €1.3bn to €850m. Reflecting the heavy PIK interest element, the amount of annual cash pay interest could drop to as little as €10m (or as much as €70m) from €115m, depending on if the company exercises its option to PIK in years one and two. 

Maturities will be extended yet again, to between June 2027 and February 2029. The 2025 bonds (which have a better and different collateral package) are unaffected, but it is expected that they will be refinanced after transaction close (expected in February 2024). 

Shareholders have agreed to subordinate their €143m shareholder loan facilities and have extended them (to an unspecified date). 

There is no mention of whether the €205m of new super senior paper is backstopped by any of the SFA lenders (or if the sponsor will participate) — we presume Albacore will be involved. 

One of the interesting elements is that those who subscribe will have €195m of their reinstated debt rolled up into September 2027 OpCo debt (which totals €345m). The remaining €666m is reinstated at a new HoldCo sitting above the HRN (Norwegian coast) and HX (expeditions) businesses — which are to be separated, presumably to smooth a refi of the 2025 SSNs.

Roll-ups are common in the US, and are seen as a less aggressive means of achieving the same result as an uptiering transaction. But we have seen few happen over here. 

No debt-for-equity swap for lenders. But holders of the new super senior and OpCo senior secured paper are granted synthetic equity instruments at transaction close (perhaps similar in form to Albacore’s warrants?). Titled as CVRs (contingent value rights?) these are instruments “which ratchet in value depending on certain conditions and could result in a material recalibration of the equity economics in favour of the lenders”.

This suggests that if the business is unable to meet its lofty targets there is a mechanism to increase the equity share — but does this come with any control, or voting rights?

The business plan is very ambitious, and the heavy PIK element means that despite a significant jump in EBITDA projections, the business will still be highly levered in 2027/28. This is down to the debt stack growing by 36% — from €1.7bn on day one to €2.3bn in FY 27. So, if the biz hits its FY 27 €280m EBITDA target (from €95m in FY24) it will still be 7-8x levered by our calculations. 

More encouragingly, even if it fails to meet half of its initial guidance, at least it would be able to service its debt and fund its operating expenses after the first two years. 

However, the Q3 conference call didn’t contain a Q&A session, leaving us and in no doubt many bondholders/lenders disappointed. FWIW the transcript is available here and hot off the press, David Orbay-Graves and Denitsa Stoyanova’s analysis of the transaction is available here

Slippery little suckers (those converts) 

The subhead above is a quote from Labour’s Barry Gardiner, who gave Thames Water’s acting co-CEO Sir Adrian Montague an uncomfortable time in an hour-long session with the House of Commons Environment Committee on Tuesday (12 December). 

Gardiner was talking about Thames Water’s latest £500m equity injection from its shareholders, which came in the form of a £500m 8% PIK convertible note issued to its troubled HoldCo Kemble Water Finance. The funds were then cascaded down to the regulated entity as equity. 

Borrowing from politicians tactics in front of the Covid enquiry, Montagu had tried to head off this issue, with an apology to the committee, as he began giving evidence. 

This July, Thames had described the shareholder contribution of £500m as equity, which he said “had been fiercely challenged,” and while they stand by what was said at the time “I think we were not clear enough in unpacking the different elements of the shareholders’ contribution, so I am sorry if we caused any confusion.”

At this point, I would agree with most of you who would say that shareholder loan notes are a typical way for sponsors to inject money, and journalists' ire at this is both misplaced and naive. 

But this isn’t a typical situation, given the presence of restrictions imposed by the WBS ring-fenced structure and a regulator who can determine whether upstreamed cash is a breach of the license agreement and can block payments. 

Effectively, the issue of the convert could be seen as piling yet more debt at the HoldCo. Is it another way of giving shareholders a return on their money, given the prospects of regular dividends via equity are remote, for at least a decade?

Gardiner wasn’t going to let Montague off the hook easily after his non-apology, apology. 

“Lets focus on this convertible note… And if I may quote Julia Roberts in Pretty Woman, slippery little suckers, ain’t they, those convertible notes!” 

Whether the converts are treated as debt or equity is moot, and Gardiner zeroed in on this, asking if the conversion is mandatory — if it is convertible at the holders option, it wouldn’t be treated as equity, he argued. 

Montagu interjected saying: “It may help if I say I agree that the note is debt.” 

He added, that he didn’t believe that the conversion was mandatory. 

But Gardiner noted another interesting point, if the coupon is not paid in cash, ratings agencies could still consider it as equity… hmmm, very handy, they are slippery little suckers! 

And there is also the tax treatment, if the coupon is tax deductible it is seen as debt. The issuer has told the tax authorities it is debt, but the committee was told before it was equity, and Thames Water has referred to it as equity injection in all of its public communications. 

So far, so entertaining. Some of us love to see Thames Water executives wriggle on the hook, but why does this matter to us in the restructuring and debt advisory community?

Well, we’ve tried to pick apart the difficulties at Kemble Water and its reliance on dividends up from Thames Water to service its debt in past versions of the Workout, and individual pieces. 

Ofwat has asked for clarification over a recent £37.5m payment that was upstreamed, and Thames has referenced a going concern warning over £190mm of term loans at Kemble which are due in April. Its 2026 SSNs are wrapped around 50, reflecting default concerns, with Moody’s downgrading to B3 with a negative outlook this week.

In his evidence, Montague said that they would seek to negotiate with lenders “early in the new year” to extend the April 2024 maturity. The rationale is that things will be much clearer from a financial perspective in June, when Ofwat makes an interim determination on Thames’ proposals. 

To this observer, it seems very late in the day to chat to a group of international institutional lenders and pension funds about an extension. Then again, even if they tried to enforce, I’m not sure on first blush how far it gets you, so perhaps Thames’ advisors are banking on this. 

I assume some Kemble lenders (and advisors) were listening in to the hearing, and no doubt will be shocked by Montague’s use of the R-word — restructuring, not refinancing. He said:

“…Everything will be much clearer from a financial perspective after we have received Ofwat’s determination….And then it will much easier to see Thames’ future and to decide how to restructure that debt.” (our emphasis) 

However, the proposal isn’t the only factor at play here. Thames Water this week, said that the Ofwat investigation into water companies which began in November 2021 “have now reached the next stage.” There is a para in the release (no doubt written by expensive lawyers) that the initial findings are without prejudice and there is no conclusion made of any contravention, or failure. They then add if Ofwat ultimately does so, it could impose a financial penalty of up to 10% of the relevant turnover.

Surely, that would be game over for Kemble, and be very tough for Thames too. 

And Ofwat’s powers have been boosted. It is now able to place the regulated business in a cash lock-up, stopping any cash leaving the regulated business (reproduced below).

This comes into effect in April 2025, to coincide with the new five-year regulatory period. At the moment, Thames is struggling to meet the service delivery and credit rating (one notch better needed) amendments. This poses a challenge for Kemble debt holders. Why would you want to extend beyond April 2025, if Ofwat is able to turn off the dividend taps?

Catherine Ross, interim co-CEO, tried to reassure the committee that Ofwat wouldn’t automatically impose the lock-up, it would want to look into the circumstances and decide if the lock-up “was in the rounds in the best interest of the regulated business”. 

Another source of tension between the committee and the execs was over nationalisation clauses in four Kemble debt issues across 2018 and 2019 (we assume these are the term loans) totalling £560m. In July, the committee asked about the clauses, and the company was to investigate and write back. 

But the letter appears to have been lost in the post. 

Gardiner said that the company now doesn’t recognise either the figure or clauses. He asked whether the purpose of the four series of notes was to insulate the structurally senior bits of the company from potential financial losses if Thames Water were to collapse to such a point it would have to be nationalised. 

Montague replied “there’s no obligation for those loans to be repaid in the event of nationalisation”. 

Gardiner asked “you’re saying those clauses were poorly written and didn’t provide the protection they were supposed to? 

Ouch. For the more legally minded readers the clause is reproduced below for you to pick over:

As well as spending a lot of time looking at Thames Water, our distressed team were busy following up on a number of live situations. 

Pro-Gest continues to look at all available options, including debt refinancing, asset sales and equity injection. But management resisted attempts on a conference call last week by investors to pinpoint their preferred option, writes9fin’s Denitsa Stoyanova. Asset sales are not going well, and there is no timeline for the publication of the much vaunted new business plan. And while liquidity is at a historic low, the Italian paper producer is seeking to reduce inventory levels which should boost cash and better align to depressed capacity utilisation, she notes. 

And finally, although not technically our European coverage, I would like to shout out a fantastic piece of research from our new US senior distressed analyst Kartikeya Dar —  Enviva deep dive — Missing the forest, the trees, and the guidance. This is a must-read for any Graanul and Drax investor, as it highlights the issues facing the world’s largest wood pellets producer. 

A busy week at 9fin towers, with Xmas golf parties, commons select committee hearing material, German and Austrian company/court filings and the accounts of pub cos (some PE execs appear to own their locals, more work required) to wade through. 

Huss, our co-founder, in due-diligence mode

We are working hard on year-in-review and 2024 outlooks — please drop me a line if you want to share your views on the market and your forecasts.

So, apologises in advance that some of the reading material is more legal and restructuring nerdy than usual, we have been putting in the prep work! 

An excellent latest digest from South Square, especially the article on trends on UK Restructuring Plans and English Schemes over the past year. 

I would highly recommend Kate Stephenson’s from Kirkland & Ellis “Cross-Border Recognition of Restructuring Proceedings: State of the Market which touches on judgments recognition, COMI and approaches to overcoming the rule in Gibbs and thoughts on the UK adoption of new Model Law on Enterprise Group arrangements. 

Going more low-brow, I’m not sure who at Blackstone thought that their 2023 holiday video with Taylor Swift vibes was a good idea! 

Another disappointing draw, against bottom of the table Burnley on Saturday (if we had won, could have gone fifth), we had 27 attempts and Burnley's young English goalie James Trafford made a season record 10 saves to frustrate the Albion. If we had converted one-sided draws against lowly opposition (Sheffield Utd, Fulham and Burnley) to wins we would now be third. 

But last night, a 1-0 win against Marseille, meant that we topped our Europa League group and avoid two matches in the knockout round in February, when the Champions League teams drop into the draw. Incredibly, Brighton are fourth favourites to win the competition — ahead of AC Milan. We left it late, however, with a 88-min goal from Joao Pedro, giving our manager RDZ his best moment at the club. Time to sign that new contract Bobby! 

Our German midfielder Pascal Gross was once again influential — is he the best-ever Premier League bargain? The Gross turn is one of football’s delights. 

There is a fantastic poster of Der Kaiser in last night’s match programme

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