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Private Credit 

Chris Haffenden

Absolute prices have moved little in recent weeks, but the impact of the reduction in market volatility and the successful reopening of LevFin primary has heralded the return of hairier credits to the EHY new issue pipeline. The ability of previously restructured credits such as Travelodge and Benteler to tap the market (albeit at juicy spreads and new issue premia) has encouraged some names which seemed like nailed-on A&Es to try their luck with refis.

A great example is Adler Pelzer, the German automotive supplier whose bonds spiked a fortnight ago after news broke of a €120m shareholder injection with a refi launched a few days later. It eventually priced at around 12% all-in, with a 9.5% coupon, and an unusual 4NC1 structure. 

It’s a name we’ve looked at before. Last November, we doubted that the highly acquisitive sound deadening and thermal linings business would be able to refinance without an equity injection. 

As 9fin’s Josh Latham outlined in his excellent Financial QuickTake, the shareholder injection might deleverage the business by a turn, but net leverage is arguably much higher than the published 2.1x due to a number of 50-51% joint ventures which it fully consolidates. The cash position is also enhanced by a large FY 22 working capital inflow (€42m) with management extending supplier payable days to generate short-term cash. It operates in a highly cyclical industry and without an aftermarket business, it is more exposed to overall levels of auto sales. 

With significant cash dividends to non-controlling interests (€22m in FY 22), a high tax burden and low margins, cash generation is weak. Interest costs will rise to €35.6m post refinancing (€17.5m) and at maturity there is another €25m of costs due to the OID. 

On a more positive note, docs have been tightened, but there is still a fair amount of flexibility for the shareholder to take his money back out of the business (around €75m) on our read. 

Despite the concerns above, it was a decent result for those who bought the old bonds in the low 80s (around 18% yield). The deal was heavily pre-sounded (or should that be sound-proofed?) with many holders clearly incentivised to roll into the new bonds to get the deal done. With the new bonds trading down 1-2 pts on the break, did some accounts get larger allocations than expected, or take a point or two of loss after getting out a par on the other leg of the trade? 

As I was reading the OM and helping to formulate and edit the Financial QuickTake, my thoughts went back to 2007, when the business (or at least part of it), was called HP Pelzer. Some of the company timeline is shown below.

After a period of disastrous trading in the summer of 2006, HP Pelzer was in breach of covenants. As I reported at the time, (Debtwire subs can check out the archive — and test my memory) lenders led by Goldman Sachs and Silverpoint (which bought out most of the original lenders in secondary) forced a sales process. 

PE firm MVB reached an agreement to acquire the business in December 2006, but weeks later there was no progress, and in late February 2007 the 21-day insolvency clock started ticking after BayernLB threatened to call-in its loans. Otto Prange from MVB said at the time in a terse press release, “We think it very unfortunate that twelve weeks after the mutual signatures of all the parties in December, we are now faced by a pile of fragments.” 

The lack of positive sounds was deadening. 

Helmut Pelzer, founder and majority shareholder was blamed. There were a number of additional demands and tweaks to the original deal. But MVB did, in the interim, manage to get its employees Rolf Kusebauch and Norbet Schwella in as CEO and CFO respectively. But they were abruptly fired by Herr Pelzer in late February (the worried plant union boss called me first), precipitating crisis talks. 

Knowing an insolvency filing was being prepped for 8.30am on Monday morning, similar to Boris Johnson, I had two stories readied to publish at 8.31am. 

With negotiations running into the weekend, I was reliant on one company side source to let me know whether a deal was reached or not. He liked the subterfuge too much — perhaps he regretted not following his university pals into MI5 — and wanted to talk in codewords. So Green for Go (into insolvency) or Red for Stop (deal reached) it was. 

Late Sunday Afternoon he was despondent, we were very much Green for Go, as talks had broken down hours earlier. But at 8am on Monday, he sent an email with revised deal terms, which I was frantically writing up before the 9am press release. 

However, I forgot to acknowledge his email, leading to a slew of Red for Stop text messages and voicemails, getting increasing desperate as 8.30am approached! 

One of the most interesting elements of the new Adler Pelzer bond is the 4NC1 structure, leading to speculation that the company wanted it that way to refinance at much cheaper yields in a year. 

We have our doubts if this is achievable. After all, you would have to call them at 104.75. Surely, the 14 points of premium would play havoc with your breakeven analysis? But we might have missed something, so let us know your thoughts. 

But it does raise an interesting point. With steeply inverse government yield curves, and hopes of sharply lower interest rates and inflation ahead, how should borrowers and investors position themselves? Wait for lower rates, or switch to floating rate issuance to take advantage of cuts? 

At face value it is surprising how many borrowers have been locking in fixed rate in recent weeks, rather than go down the FRN route. Part of the reason might be demand-driven, given a more limited pool of FRN buyers, and the extent to which the CLO-leveraged loan arbitrage still isn’t working, reducing the amount of issuance here (plus there is a lack of LBO deals). 

Appetite from banks to underwrite has improved in recent months, giving confidence that even large deals of €2bn-€3bn can get done, noted one advisor earlier this week. But the increase in interest costs for stressed borrowers is still a problem. An A&E for a €1bn debt stack with a 100bps margin bump and a couple of points of OID costs an additional €40m a year. This is a lot given that many borrowers are struggling to get to FCF breakeven before interest costs.

As a result many stressed borrowers are deciding to wait longer before refinancing. But this reduces their runway and potentially their options, noted the advisor. 

I certainly wouldn’t recommend leaving things as late as Lycra (signing a financing agreement a week before maturity) or Keter, which is reportedly back less than six months before maturity with another A&E after shedding goodwill with lenders with its coercive request last year. 

But while overall borrowing costs are high as ZIRP is no more — Barclays notes that the average new issue yield this year was 7.8%, almost double 2019-2021 levels — spreads are remarkably tight especially at the single-B level, the tightest relative to BBs in almost six years at less than 150 bps differential.

BofA thinks the reason that credit hasn’t cracked is that investors are no longer forced to be crowded into corporate bonds. Under-owned markets prove to be more resilient than consensus.

Higher coupons are good news for investors, as the higher running yields partly compensate against inflation and with most bonds trading below par, there is little change of being called. But increased interest costs will reduce ICR for borrowers and will eventually lead to more defaults in medium term. Barclays provides a nice table below to illustrate:

Are you being paid to take the risk of moving down the credit curve?

BBB to BB spreads have also contracted sharply, reflecting the competition between cash and credit, given that cash is finally an attractive investment in its own right. The TLDR is that Investment grade credit will have to offer a much better return to compete. 

Don’t forget the inverted risk-free yield curve works against you here (70 bps between three-month money and five years in Europe, and in the US it is a whopping 154 bps)

Source: Natwest Credit Card advert archive

After the recent ECB hike, 8% of European IG issues yield less than ECB deposit rates (3.25%). This could rise to a whopping 40% by July, assuming further hikes, which is why BofA recommends cash/HY credit barbells. 

Should HY spreads be more reflective of the upcoming recession in corporate earnings and rise in insolvencies? For now we are close to YTD tights. The key question is whether tighter lending standards in the US will cross the water. The consequent rise in US bankruptcies is noticeable.

Let it BB, S&P whispers words of wisdom for SBB

Arguably the biggest news of last week was the unpronounceable Swedish Real Estate firm, Samhallsbyggnadsbolaget (lets just call it SBB finally losing its investment grade status. 

It would have got higher billing if I’d got around to a Workout last week, but unfortunately a combination of a bad back, a raft of earnings releases and heavier than normal editing duties meant that I was just one para in by midday last Friday, so a decision was made to abandon.

On 8 May, SBB was downgraded by S&P Global Ratings to BB+ with a negative outlook. This might not seem too bad, but with hefty short term maturities (around $1.4bn-equivalent, including €700m of SUNs due next February) and a over-reliance on commercial paper (a mostly IG product) for funding, its sources of liquidity are disappearing. S&P notes that undrawn credit lines have reduced greatly from SEK 4.5bn at end of 2022 to SEK 2.6bn. 

SBB was looking to plug its liquidity hole via a SEK 2.64bn rights issue but, with its shares tanking on the downgrade, it was forced to abandon the new issuance, and it also cancelled its class D share dividend to strengthen liquidity. 

The Swedish landlord mostly lets its properties to local authorities and government institutions, and has long been in the crosshairs of short-seller Viceroy Research. It has embarked on a disposal programme and issued lots of hybrid debt to repay short-dated debt in an attempt to avoid a damaging downgrade to junk status. 

SBB received SEK 9.2bn (€808m) from selling a 49% stake in its educational assets to Brookfield, using the proceeds to repay a €750m bridge and €631m (principal amount) of hybrid bonds and SUNs at a discount. It still fully consolidates the business (around 33% of its total portfolio) in its accounts. According to S&P, “EduCo's debt structure comprises about SEK6.9bn of outstanding external bank loans attached to the transferred assets and a SEK14.5bn intercompany bank loan provided by SBB, carrying a fixed rate of 3% with a six year tenor.”

With the adjusted debt-to-debt plus equity ratio at over 60% and interest coverage at around 2x, S&P has hinted at further downgrades if SBB “is unable to secure sufficient funding sources in the next couple of quarters to sustainably cover its short-term financial obligations by at least 1.2x over a 12 month horizon”. 

But SBB’s bonds are not trading at BB+ levels, as the front end issues widened by over 300 bps on the news. Yet another Commercial Real Estate fallen angel to add to our list. We will be running out slide rule over the business in more detail over the coming weeks.

As many longstanding Workout readers are aware, short-sellers have had a productive time on picking targets in high yield real estate names. SIGNA Development management have spent a lot of time trying to convince investors they should be viewed differently from Adler Group, Aggregate, and Corestate. In previous earnings calls management have taken a sideswipe at SIGNA’s tainted peers saying the company does not include receivables and net financial assets in its LTV calculations.

But its accounting methods are not without criticism. The company aims to forward sell at least 50% to property investors before completion. It doesn’t receive the sale funds until completion but does book the revenues using the aggressive percentage of completion accounting treatment. This boosts EBITDA and reduces LTVs by increasing Gross Asset Values.

And while its peers were more cautious on the German Real Estate market as the second half of 2022 progressed, SIGNA had remained upbeat, talking up its sources of liquidity.

On Wednesday, SIGNA revealed a 11% decline in the valuation of its property portfolio, mainly due to rising cap rates, with its large development portfolio showing the sharpest decline. 

As 9fin’s Hazik Siddiqui writes, “Real estate assets are long duration in nature — meaning their valuations are highly sensitive to interest rate movements. Higher interest rates also reduce real estate market liquidity, leading to wider bid/ask prices for property assets as the market readjusts. This creates ‘rising cap rates’ phenomena, eroding property valuations.”

CFO Manuel Pirolt revealed that SIGNA’s conference call, originally planned for the last week of April, was delayed because CBRE and other evaluators were taking longer than expected to complete their appraisals as “there are less comparable transactions out there”.

Despite the poor transactional backdrop, SIGNA has earmarked an ambitious €500m+ of property disposals for 2023, claiming that two transactions are in ‘exclusivity stages’. The FY 2021 dividend of €114m, approved in summer last year was delayed as a precaution, as SIGNA waits for the negative sentiment to improve. It also decided to close its existing development pipeline before starting new projects is going to be the prime (pun intended) focus.

When quizzed on how SIGNA plans to address its 2023 project debt maturities (€473m due), management replied that project debt is usually repaid once the real estate project is completed and sold. They added: “If the project is delayed, then you would typically prolong the loan.” 

SIGNA can point to a number of transactions last year to prove that it still has market access. In 2022 alone, SIGNA raised over €750m via various funding tools including equity, project debt and subordinated profit participation notes. Year-to-date 2023, SIGNA said it has raised €200m of project debt and is in the process of raising another €30m at a credit spread of 200 bps. 

If alternative funding sources remain available, then SIGNA may be able to dampen the noise, but with at least €300m of funding needs for the next two years, and 77% of gross asset value under planning or in construction phase, their situation is certainly not without risk. 

The 2026 SUNs, after dropping into the high 40s after their German-only release last week, have since clawed their way to the low 50s, a lofty 29% yield. At least the planned €50m bond buyback is supportive, but that’s conditional on getting disposals away. 

With Adler Group, Aggregate, Demire, Vonovia, Vivion, and DIC Asset having reported their FY 22 numbers, the state of the German Real Estate market is becoming clearer. 

Yielding office and logistics assets are holding in well, due to a combination of strong lettings performance and indexation effects. Residential is holding in less well, however, with Adler Group projecting a 10% fall in values from mid 2022 levels, with a mild rebound in 2024. Bloomberg reported on Thursday that Vienna was the weakest residential market in Europe (even worse than Stockholm) with 12.2% fall from the highs, which is not good news for SIGNA.

Development asset valuations are much more interest rate and cap rate sensitive with the cost of development finance more susceptible to market sentiment. Developers have also suffered from increases in construction costs, which increases LTVs, and with deal flow drying up, many are slowing down project builds to preserve liquidity. Conversely, values could be pressured by a number of distressed RE players seeking to offload assets in the next 12-24 months. 

Real Estate asset managers such as Corestate and DIC Asset are also susceptible to transaction volumes. The drop off in activity in Q1 is nothing short of dramatic, with CBRE saying that property investment dropped 71% in the first quarter. This makes it difficult to appraise the true state of the market, and as most companies only revalue their properties at full year (and some at half year too), we must pick apart individual sales to garner further deterioration since year-end.

LTVs are creeping higher, above target ranges, and in some cases are close to covenanted levels. Raising equity is one solution here, but this could be problematic as stock prices have been under significant pressure as equity cushions erode. 

Equity investors are starting to get twitchy, witness the comments from Union Investment at Vonovia’s AGM, “in its current state, Vonovia doesn’t look like Europe’s largest housing group, but a skyscraper on shaky foundations”. 

Prices of German RE high yield bonds are at least reflecting the (unsecured) risk, with many names trading north of 20%. With secured funding still available at attractive levels, those with unencumbered assets and secured debt headroom might still be okay, if the banking market remains open and financing costs remain (relatively) cheap. 

But many are relying on disposals in addition to other means of financing to meet maturities. Several have limited runway, with debt maturities in the next two years, such as Vivion with €700m of Aug 2024 SUNs; Demire with €600m of Oct 2024 SUNs; Summit Germany with €300m of Jan 2025 SUNs, and of course Adler Group with around €2.5bn in mid 2025. 

For the brave and those willing to do the heavy lifting there may be some bargains to be had. We are doing research here, and will be putting together a report on the sector in the coming weeks. 

McLaren is running out of highway. Suffering from high cash burn in Q1 23, we project without an agreement with shareholders for a comprehensive recapitalisation plan, it could run out of funds during Q3 at current burn rates. Management were tight lipped on amounts and timing. 

NovaFives’ chances of a refinancing may have risen markedly, if a report in L’Agefi that public sector investment bank Bpifrance is contemplating taking an equity stake in the French engineering group is correct. Its June 2025 bonds jumped five-to-six points on the report. 

While we wait for creditor talks to kick-off, we are close to a full set of advisors, with Groupe Casino MTN holders coalescing into an investor group advised by DC Advisory as financial advisor and Ashurst as legal advisor, writes 9fin’s David Orbay-Graves.

After dealing with supply chain disruption, soaring inflation and high energy costs in 2022, Consolis had a poor first quarter due to demand headwinds, writes 9fin’s Denitsa Stoyanova. Liquidity is weakest for five years, with management taking steps to reduce its cost base. 

Finastra has been on 9fin’s watchlist for some time. This week, my US colleagues revealed that the troubled software company is exploring a $2bn second lien PIK as part of a $7bn private credit refi plan. With low interest cover and leverage above 8x, it won’t be an easy sale. 

Ideal Standard management decided to host a pre-recorded conference call on Wednesday, as performance (especially cash burn) continued to disappoint, writes 9fin’s Josh Latham. A €25m loan facility has bought some time, and has further room to prime bondholders. 

After a disastrous coercive A&E request last November Keter is back with another attempt, according to Reorg Research. Minority shareholder PSP Investments is injecting €100m of equity and convert its €300m HoldCo PIK in return for a A&E. BC Partners has yet to decide on its move. 

Most of the past fortnight was spent going through investor presentations and transcripts. Our CEO let the cat out of the bag on LinkedIn earlier this week, yes, there is embedded GPT for searches within the text, which matches with the attached audio file.

The tool is super helpful in wading through the conference calls, with SIGNA Development; Upfield Flora, Pure Gym, Schoeller Allibert, Ideal Standard, Maxeda, Consolis, McLaren and Lowen Play among the notable names reporting. 

I would also recommend Cloud 9fin’s interview with our own Brian Dearing on Lycra’s Drop Down Variant.

One for the reading list this weekend, is whether the refusal of the English Courts to approve two separate SME UK Restructuring Plans in which HMRC successfully opposed being crammed down has wider implications. Luckily, Kirkland & Ellis has a handy summary, available here

Beware of using the F-word. Our colleagues at the FT have been investigating The Hut Group’s accounting and business model for at least a couple of years now. Rob Smith and the team spotted this in the annual accounts earlier this week: 

Which prompted an twitter storm from Matthew Moulding, CEO and Founder who pointed out that this language appears in virtually every set of audited accounts in the UK, including the FT whose auditors saw fraud risk in advertising revenues and management overriding controls. I’m looking forward to the how this spat develops. 

Jeffery John Bell (of the legendary Gunmakers Arms, for Workout craft beer fans) has an Italian friend who is about to take his UK Citizenship test. I assume answer B for this mock question is not the right answer, but it should be:

And finally, its been a rollercoaster couple of weeks for the Albion, losing 5-1 at home to Wolves, then destroying Arsenal’s title hopes with a 3-0 away win, and then losing 4-1 last night to Newcastle. 

A combination of five games in 15 days, a growing injury list (we had three 19 olds on the pitch last night, with no recognised full back or right sided winger) has led to a fraught end to the season, and if we can hold onto the sixth spot for the Europa League. As my son Charlie points out, in his article for Birmingham World, if VAR didn’t exist, we would be six points better off and challenging for the Champions League.

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