Market Wrap

Friday Workout — Trickle Meltdown; Recap Ready; Intrum Judgment

Chris Haffenden's avatar
  1. Chris Haffenden
14 min read

Three weeks ago, I pointed out that investors needed higher compensation for investing in the UK and that the pound (I had cheekily renamed it as the North Atlantic Peso) might have to weaken significantly to attract foreign buyers of gilts. But even this permabear wasn’t expecting the aftermath of last Friday’s Kami-Kwasi mission statement.

Wowsa — three and four standard deviation moves in rates and currencies, in the worst week since 1992 for sterling assets! It happened just a week after the 30-year anniversary of the fateful day when UK base rates gyrated between 8% and 15% as we were dumped out of the ERM.

I suppose we should applaud politicians for actually carrying out election pledges, however inappropriate or ill-timed they now appear. But if this was a sports event, some might be investigating irregular betting patterns. Just as MMT is in hindsight seen as a dangerous mistake for its widespread adoption during Covid, dashing for growth at a time of surging inflation and large twin deficits may end up worse.

This policy of Added Fizz from Liz is now vying with Erdogan-mics for the title of most radical countercyclical economic ideology. Did they think that raising borrowing by £85bn to £185bn (7.5% of GDP) and Gilt supply to over £250bn over the next two years would be Atlas Shrugged by the markets?

Labour’s David Lammy deserves a Perrier Award for this tweet:

We then had big hitters such as Larry SummersMohamed El-ErianMark Carney and most notably the IMF expressing their deep concern, calling for the plans to be reversed. But Liz and Kwasi hunkered down, and were absent from our screens (although not necessarily our ears) this week. For the most part, junior ministers were left to blame worldwide events such as the war in Ukraine as reasons for the run on the pound and the crash in gilts, rather than fessing up as the creators of this crisis of confidence.

The FT sums it up well, disagreeing with The Mail and Torygraph and refusing to blame the city boys:

Deutsche Bank (a repeated hat tip for their unerringly right call on an upcoming balance-of-payments crisis) nailed it in a research note on Tuesday:

“The cause is a confluence of three factors that we have been writing about for a while: (i) an environment of dramatic risk aversion where global capital is being withdrawn and hoarded in dollar cash; (ii) the UK’s huge external deficit, the largest in the major DM and EM world; and (iii) an exceedingly slow monetary policy response that has prevented UK real yields from rising and poorly communicated the central bank’s commitment to its inflation target. It is these three conditions that have all combined with the announcement of a large, unfunded fiscal package that have led to the UK’s funding lapse.”

After the BoE finally stepped in as buyer of last resort (note that it didn’t provide an emergency rate hike) it emerged just how close we came to a systemic event.

After dire warnings from visitors to Threadneedle St, the BoE got out the big guns, dusting off its bazooka offering to use up to £65bn of ammo. From the FT:

The Bank may have stabilised long yields (30yr Gilt yields fell -105.9 bps on Weds) and avoided widespread pension fund insolvencies, but in my view, their intervention and delay in QT must lead to even higher rates. I suspect the focus will now shift back to the currency in coming days and weeks if the Bank decides not to act before its next meeting. The market is implying a 150bps hike in Nov.

I tend to agree with Jim O’Neill that the pound is probably undervalued (conversely the dollar is very overvalued), but as he said yesterday, we could be repeating Reagan-era policies with highly expansive fiscal policies in common with former Emerging Market pariahs such as Brazil and Turkey — compounded by monetary policy that is still too loose (real rates in the UK still remain the lowest in Europe). This means we need to offer higher rates and a cheaper currency than fundamentals might suggest, and these could overshoot even further in the near term.

I was on holiday in Cornwall with intermittent 3G last Friday, so I missed the big moment. It nicely bookends the two crises — I was under general anaesthetic on Black Wednesday for wisdom teeth extraction (don’t judge me, the gas was on offer, and the surgeon later said they were the largest roots he’d seen; a Barney Rubble doppelgänger post op) and thus missed BarCap’s most profitable day ever (and the epic post work drinks). But at least I avoided a monster hangover and could cover the desk the next morning!

Catching up this week, there was a sudden rush at 9fin Towers to understand Liability Driven Investment (LDI) strategies and how its dark magic works. Who knew before that pension funds were using up to 7x leverage to close their unfunded gaps? This tweet offers a glimpse of how we got here:

As Morgan Stanley explained: “The common denominator of all those activities is that they are long UK duration, long inflation risk [given big chunk of issues are index-linked] and long leverage. The latter means they are short volatility. And this is the main source of the problem.”

These are huge moves, the 20-year Gilt by more than 150bps in less than three trading sessions. As Owen Sanderson points out in this week’s Excess Spread, the 2073 index-linked gilt price halved in price in two days! It took over five months for the Austria 100-year bond, our other long duration fave, to show the same move earlier this year.

Asset managers were forced to dump huge positions (in the billions) to meet margin calls, even including ABS paper bought less than two weeks earlier, as 9fin’s Owen Sanderson tweeted.

By this point, you have probably had enough of the macro and technical stuff around gilts and pension liabilities. So: what are the potential repercussions for LevFin?

Firstly, you should prepare for risk premiums for GBP assets to continue rising.

Bloomberg have a great chart here, measuring the difference between the index spread and new issue coupons for IG credits — it’s worse than the GFC! Is this a result of managers dumping other assets to meet margin calls? On this basis, HY and Lev Loans may be vulnerable.

Source: Bloomberg

Looking explicitly into HY, we ran a 9fin price-move screener yesterday and found that 31 GBP bonds from 19 issuers saw price moves of over 5% in the past week. Debt collectors, retail, pubs, homebuilders, and gyms feature heavily in the list, as does Together, the mortgage originator.

Yes, before you ask: on a spread basis, 12 of the 19 saw spreads to worst widen by over 50bps. Among the biggest movers were Together’s SSNs (+142bps) and Boparan’s SSNs (+164bps).

We also looked at UK issuers that fell more than 5%, which featured 42 bonds from 24 companies. Once again, debt collectors figured highly (this is not just about their borrowers and funding rates — more on this later) and names with significant non-UK expenses, such as Jaguar Land Rover.

Over the next few days, we will be using our screeners and journalist intel to establish which companies could suffer from currency mismatches — those with a lack of hedging of FX risk or imminent hedging roll-offs and/or those likely to suffer from a reduction in discretionary consumer spending (for many people, the rise in mortgage payments could dwarf the energy bill scare a couple of months ago). There could also be tailwinds from higher rates for financial issuers, or those with non-GBP revenues but GBP cost bases.

Time to scour 9fin’s docs database (for OMs, financial reports, transcripts) for specific mentions. But with most of these moves happening after Q2 reporting, for many companies this is only now coming into focus — a few weeks ago, most of their attention was on energy and input cost rises. Analysing the impact will require some more legwork first, so watch this space for our initial list.

There is also an argument for widening this analysis out to Eurozone companies and Euro issuers with USD exposure, given the sharp appreciation in the dollar. But one thing at a time.

Real Recap Ready?

One company definitely on our list is Matalan, the UK discount retailer.

It sources most of its stock from the Far East and pays for it in US dollars. Luckily, it hedged its FX exposure at an average rate of £1/$1.37 vs a current spot rate of £1/$1.08 for FY23. But this hedge will expire in February, as it will for its energy costs. This means that Matalan’s £81.3m run-rate EBITDA should be haircut significantly, according to some of the advisors working on tackling the company’s £350m January 2023 SSN maturity.

Earlier this week, the company confirmed that a sales process had been launched, with an ad hoc group of SSN lenders offering to provide £200m of staple financing to interested parties. To allow time for completion, they committed to extend the maturity by six-months.

The company said the ad hoc group has also “committed to a recapitalisation transaction (if required) which provides a positive outcome in all scenarios for Matalan and for the benefit of our employees, customers, suppliers, and other stakeholders. This alternative recapitalisation would result in a material reduction of Matalan’s debt and an extension of the maturity of First Lien Secured debt from January 2023 to September 2027.”

So, what are we to make of this?

Firstly, it’s worth noting there is also £80m of second lien debt outstanding (the founder and major shareholder the Hargreaves Family owns at least £20m) whose holders are complaining of being left out of the process. The shareholders had offered to step in again to support the business (as they did in 2020) but reportedly, first lien lenders are not happy about the amount offered to smooth an amend-and-extend transaction.

This has led to a ‘strategic sales process’ which the Hargreaves camp says is just to create negotiating tension, with no alternative bidders likely. Our initial analysis suggests an EV multiple of 4x-5.5x is appropriate, and that after haircutting the LTM figure the value is likely to break in the First Lien.

We assume that the first lien believes £200m is the maximum amount of sustainable debt, which on our initial reading makes sense: more than 4x is too toppy, and a 50% LTV would suggest less than 3x.

So, with £430m of debt to clear (£480m if you include the ABL facility), Hargreaves and the second lien will have to pay to play — either to reinstate their equity, or to provide better financial terms than provided by the first lien. Pricing for the staple, we suggest, is likely to be in the low to mid-teens based on peers such as Asda and Iceland.

We think it’s by no means a done deal for the 1L, as reflected in their trading price in high 70s. Our understanding is the ad hoc group is some distance from the 75% needed to implement a restructuring via an English Scheme or UK Plan, and it is complicated by a number of cross-holdings in the 1L and 2L. Many involved believe the 1L are not keen to own this business. Hargreaves is still in play.

In any event, it is unlikely to conclude quickly, with plenty of possible twists and turns to come.

An interested onlooker is Apax, longstanding sponsor of Takko (the German retailer with maturities in November 2023). This week management said they feel confident they can successfully complete the refinancing within 12 months and the company can continue to operate as a going concern. But they failed to give clarity on their plan of action, reports 9fin’s Lara Gibson. Unfortunately, her piece was delayed as the company decided not to allow non-bondholders on yesterday’s call, so it took a while for us to catch-up — shame on you for chicken-king out.

Takko flirted with an insolvency last spring after failing to secure a €75m KfW loan, with Apax and related parties stumping up €53.6m of loans. In Germany, managing directors of companies are required to file for insolvency if there is an imminent liquidity event or if they fail an over-indebtedness test which measures if they can guarantee solvency for the next 12 months.

Spooked by rising energy costs, German’s Ministry of Justice has recently drafted legislation to reduce this period from 12 months to four months (see our detailed piece here) and the motion is expected to be passed in the coming weeks, which might give further breathing space.

But Matalan shows the dangers of waiting too long. We would love to know what was offered this February by investors in the GS-led pre-sounding process — give us a call in confidence.

Intrum Judgment

The appearance of Lowell and Arrow in our biggest movers list is not entirely down to recent machinations in the UK. Late last Friday, Swedish peer Intrum announced a write-down on some Italian secured NPL portfolios, cutting estimated remaining collections by €138m-€156m.

As Owen Sanderson wrote, “It was clear from the hints in the release that this was the €10.8bn portfolio Intrum and CarVal bought from Intesa SanPaolo in 2018 — Project Savoy, subsequently securitised into Penelope SPV, which was itself restructured into GACS [Italian government senior guarantee] friendly format in late 2021.”

From close until June this year, the last reporting date, Penelope is 5.8% behind business plan — not unusual in the broader GACS context, but a pretty rapid slip behind.

The structural incentives of the GACS (get as much of a transaction as possible to BBB- rating by picking the servicer with the rosiest outlook) have left much of the market disappointing vs initial plan. Owen adds that there is a hint that even more writedowns could occur once CarVal sells its stake in the portfolio, with Intrum saying: “Any sale to a third party of the stake in the Italian SPV currently held by Intrum’s co-investor would be considered as objective evidence and could potentially lead to a further adjustment of the book value.”

We don’t know whether CarVal is shopping its stake around (Intrum has an option to buy it out, which becomes active next year), but as Owen suggests, it seems plausible for a financial investor which has been in since 2018 to be scoping out the exits.

Intrum said in its release that it didn’t need to write down any other positions, but the market was unconvinced, with shares down 20% on the news. Most of the other debt purchasers don’t have listed shares (though DoValue was down 10%), but bonds were ticking down for AnaCap and Arrow (despite the possibilities of a healthy UK NPL pipeline down the road).

As Owen concludes: is this an early signal that Italian NPL marks are going to have to come down a long way?

As you can see below, debt purchasers dominate our biggest fallers this week.

In brief

Orpea, the beleaguered French Care Home operator admitted this week that it might have to approach banks for covenant waivers in the second half, as it continues to be hit by rising costs that are likely to intensify. On a more positive note, it has managed to draw €796m of its €1.5bn optional facility, which has made some dent in refinancing near-term maturities. But conversely, it is well behind on its property sales target, with just €94m sold. Its bonds have hit fresh lows. Look out for further analysis from Denitsa Stoyanova in the coming days.

Tullow Oil decided against making an improved offer for Capricorn Energy, after its target said yesterday it had agreed an improved offer from Israel’s NewMed — which includes a $620m special dividend to Capricorn shareholders. A number of high profile Capricorn holders had publicly expressed concerns about the Tullow terms. Conversely, the Tullow will now lose the benefit of over £1bn of cash to help it deleverage and refinance expensive senior secured debt. The 2025 SUNs fell around 15 points into the high 50s on the news.

Intralot announced that its 2024 bondholders have dropped their US legal action. As previously reported, the SUNs were seeking compensation from being J.Screwed by a deal the 2021 noteholders penned at the time they were pari passu, which left them secured by the company’s best US asset and able to refinanced it out in under a year. At time of publication it is unclear whether there is something in the works — if you are involved, drop us a line.

What we are reading this week

It was a close run thing for the best cover this week, but I think the New European wins

It wasn’t just tax cuts on the agenda in Kami-K’s mini-budget; there are major changes to planning approvals. This has resulted in militancy and calls for direct action from an unlikely camp — millions of Twitchers who are members of the Royal Society for the Protection of Birds.

Sticking with Wildlife, a Fractional Reserve explainer:

9fin-ers were quick to wade in with their responses:

I do think the squirrel economy seems very unbalanced — a bunch of work shy animals, terrible credit risk, why are the weasels lending to them when the squirrel does everything?

There is a general anti-Weasel sentiment, but we forget that they play an important role in a forest reserve that makes independent decisions. Especially during conker season when cheap nuts get pushed into the market and seem to be siphoned off to small gardens with less oversight.. (as uncovered in the park-ama papers)

And after a couple of days of relative calm, you might have thought it was safe to reenter financial waters, but the European Systemic Risk Board says — STAY OUT OF THE WATER

The ESRB cites energy costs, pipeline sabotage, and overheated housing markets after sharp rises in mortgage rates, and most notably, the Commercial Real Estate Sector:

Given that profit margins in the Union’s CRE sector are already low, these developments could render some existing or planned CRE investment projects non-profitable, increasing default risks and compounding concerns about CRE-related non-performing loans, which are already high and rising.”

Finally, I think Marina Hyde should have the last word in an historic week:

As for Kwasi’s boss, Liz Truss famously promised to “hit the ground on day one” – and she really does seem to be boring right down into the Earth’s crust. Their negative impact is so great that Nasa want to use her and Kwarteng to fire into asteroids. For now, I’m sure none of us can believe all this is happening on the watch of two of the authors of Britannia Unchained, which always sounded like a version of Atlas Shrugged set in a Surrey business park.”

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