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Private Credit 

Chris Haffenden

A lot has happened since my holiday at the end of last week, which was followed by a couple of days out of action with man flu. Stability and integrity were in short supply in my absence. Our trust and belief in stable geniuses has certainly taken a battering in the interim.

Ahead of the US mid-term elections, we faced the prospect of the Chief Twit removing content moderation and maybe re-platforming an overtly orange Floridian while charging us all $8 for a blue tick or forcing us to fly the coop to Mastodon. We then had an acrimonious dispute from a bunch of anachronisms, SBF, CZ and FTX (perhaps if I changed my name to HFF, I might get a million more eyeballs) as Crypto may have just had its Bear Stearns and JPMorgan moment.

And just as we thought that another bear market rally had been stopped in its tracks by a Crypto crash and concerns about contagion, a lower than expected US CPI print on Thursday provided blessed relief for bruised and battered bulls, and led to a sharp reversal in crypto tokens.

Right now, it’s a great time to be financial journalist and/or a conspiracy theorist. Did Binance deliberately create a run on FTX’s FTT token (sorry, yet more anachronisms) to force its smaller competitor out of business and then try to buy it out for just a dollar?

Got to think that wouldn’t be a smart move, as it would surely create a run on the whole industry? As one analyst said this week, its not a great idea to set a neighbour’s home on fire, when it’s the downstairs apartment! My view is that he [Bankman-Fried] acted on last week’s Coindesk story to offload their own FTT risk and score points over a rival. I will take his subsequent note to Binance employees at face value.

How many more times will we attach greater intelligence to these visionaries? Just like on the trading floor, some supposedly great traders just got lucky with a risky trade(s) and/or the timing just right to ride the big wave all the way to the beach.

Survivorship bias is a wonderful thing. We never attribute anything to luck, it’s always our superior skill. In hindsight we can retrofit our past actions as a narrative for successful outcomes (it helps secure future funding) — Harry Hindsight is indisputably the world’s greatest trader.

In finance and in tech, we are suckers for financial engineering and new techniques, readily believe in new paradigms, and are charmed by larger than life characters who promise to change our world. If we are early adopters, the rewards are life changing.

Is Elon Musk really smarter than Einstein — as one of his staff claimed on a recent BBC documentary? Or did he persuade enough marks to part with their cash and remain true believers as deliveries were delayed and promises for autonomous cars and electric trucks were broken? Before hitting the trillion, he faced bankruptcy many times, with Morgan Stanley famously bailing him out. I wonder if they are rueing that decision given their bigger exposure to his Twitter debt?

Sequoia thought that SBF was going to have the same impact as Elon, but for Finance:

This initial assessment hasn’t aged well. After participating in the latest round in April which valued FTX at $32bn, the giant venture capital fund faces losses of over $150m as Binance pulled out from its LOI after less than 24 hours of due dil.

There is now talk of a $8bn plus financing hole at FTX, with SBF’s hedge fund also expected to go under, with FTX likely to file for bankruptcy if a new backer cannot be found.

Hat Tip to Robert Smith at the FT for reminding me about Sam Bankman-Fried’s famous Odd Lots podcast with Matt Levine, in April on how decentralised finance really works. It was the moment when I suddenly realised that I wasn’t the dumbest guy in the room for just not getting it, here was an industry insider saying that DeFi walked like a duck and quacked. For those who don’t have time to listen through the one hour and nine minutes (it’s worth it if you can), this FT Alphaville piece sums it up excellently:

“if you like to gain greater insight about ‘valuable boxes’ with no economic use case that go ‘to infinity’ because of ‘the bullishness of people’s usage of the box’ don’t forget to sign up for the FT’s Crypto and Digital Asset Summit beginning Tuesday.”

At the time we weren’t looking at the trading platforms as the cause for the expected crash. It was the crazy leverage in the system, token scams, and the instability of stablecoins. SBF was just being transparent and mapping the universe that his trading platform was part of. After all, he was talking to regulators, wanting to make changes to make the system more robust, a good actor and one of the smartest guys in the room.

Michael Lewis’ upcoming book might need a new Chapter or two!

On Thursday, SBF admitted he messed up, twice.

We will know in the coming days if a rescuer can be found. If not, we go back down the Celsuis bankruptcy route to see whether coins in customers accounts held at FTX are protected or are the property of the platform. The US operations are claimed to be fine, there is no FTT in there as the SEC would probably deem it as a security, hence the need to run two separate exchanges.

In the meantime for true believers and for the bold, is it time to invest in Crypto-squared MicroStrategy 2028 SSNs at 12.75%, or Coinbase 2028 SSNs at 15%?

Marathon says its not time to sprint, but KKR is already off and running

We are getting to the time of the year, where we start look at the current state of markets and think about returns for the year ahead. 2022 has been one of the worst years in history for bond investing and spreads have widened markedly, with even decent single-B names now having to borrow in double-digits. Global HY is down around 17% in total return terms, with IG down 20%.

The BofA European Credit Strategist note points out that we have never had two consecutive years of global HY total return losses (three years for IG). 2023 should be better than 2022, barring much worse than expected macro shocks, they say.

KKR is even more bullish, saying that the hunt for yield is over. “Leveraged credit markets in Europe and the US are awash in yield and not only for the riskiest credits.”

The opportunity in Leveraged credit is better than any time since the GFC, they say.

Bond prices are now at deep discounts to par, the US HY index is around 85 in cash price. Historically returns in the next 12 months have been stellar, note KKR.

But much of 2022’s price moves were driven by increases in risk-free rates, and while spreads have doubled since January, they are some way from this year’s wides, and not at historical extremes. At time of writing, the iTraxx Crossover has finally broken out of its 650-500 bps range, closing on Thursday at 487 bps, after hitting 675 bps less than two months earlier.

BofA believes that 2023 will be a better year for HY returns. But for a stellar year we will need Central Banks to pivot. Yes, we’re back to the recession versus inflation and the who blinks first debate.

I agree with KKR that technicals (especially for CLO tranche investing which is incredibly cheap to the underlying) have resulted in a lot of dislocation. You don’t have to find distressed (in terms of credit, not price) names to find decent value. It is also worth noting that while July’s rally saw high beta names rally hard, this time around the dispersion of performance was much wider.

Another key question is when/if LevFin markets will once again become functional. CLO technicals are poor, managers have limited cash, it is set to get worse as more are outside their reinvestment periods with little chance of resets unless prices and spreads move substantively.

Which means borrowers will be likely looking at creative solutions to deal with 2024 and 2025 maturities, rather than going to primary markets to refinance. But as Keter showed, many CLOs are unable to extend as they are now out of their reinvestment period. Loose docs are conducive to a lot of potential shenanigans, you have been duly warned. Owen Sanderson’s Excess Spread this week suggests at least 10-15 A&E requests are coming your way.

Clearing out the A&E queue might be one way for the EHY market to get back into better health later in 2023.

As always, it is good to have another viewpoint. Marathon Asset Management’s The 2023-2024 Credit Cycle Public & Private Credit Markets Outlook & Opportunities White Paper Q4 2022 (and breathe) is an excellent piece of thought leadership.

From the Exec Summary (I’ve bolded for emphasis):

“The credit markets today represent one of the most anomalous investing periods since the advent of the high yield bond market in the 1980s. Persistent inflation and higher interest rates have created significant challenges for companies, corporate earnings outlook, and creditworthiness. The Federal Reserve, along with central banks abroad, have embarked upon a policy path of tightening financial conditions to fight inflation, collectively raising rates at the most aggressive pace in recent history. With higher interest rates and wider credit spreads, the cost of capital has begun to constrict issuer cash flow generation, dampen valuations, and limit refinancing prospects.”

“The U.S. and European non-investment grade credit markets have tripled in size since the Global Financial Crisis (“GFC”), from $1.7 trillion to $5.1 trillion. This was largely due to zero interest rate policies that enabled low-cost capital to fuel the credit markets to grow disproportionately to GDP during the past decade, creating a larger basket of riskier assets compared to past credit cycles. Companies levered their balance sheets to take advantage of cheap capital as investor demand for yield surged.

Leverage ratios have now reached 20-year highs, creating unsustainable capital structures for a large cohort of corporate obligors. Covenant protections have eroded, reducing default probabilities and future recovery values for companies that will ultimately require a restructuring solution. Aggressive earnings projections have driven a significant divergence between adjusted EBITDA and actual cash earnings. Given the confluence of these factors, we believe that there is a reasonable probability of 2,000 downgrades and 200 issuer defaults during the 2023-2024 credit cycle.”

“This credit cycle will be defined by a recession with persistent inflation that we expect will result in an enormous multi-faceted opportunity to deploy capital in both the private credit markets and dislocated secondary credit investments in the public credit markets. Europe will present a multitude of credit investment opportunities given the magnitude and severity of the challenges the region faces. Investment managers who are experts in navigating complexity in both public and private markets will be best positioned to capitalize on this upcoming opportunity set. The consequent fallout across the most vulnerable segments within the corporate credit markets will be felt by businesses that are over-levered, struggling to manage their balance sheets, and unable to generate free cash flow. The prevailing wisdom is to remain patient waiting for “Good Companies with Bad Balance Sheets” in order to invest at entry points that are highly opportunistic.”

Marathon thinks that true leverage is much higher than raw figures would suggest (even on reported figs 33% of loan issuers were levered over 6x). Loans are much more vulnerable than bonds due to floating rate risk and higher proportion of single-B borrowers. Moody’s say 47% of B3 rated borrowers cannot cover interest expense at current rates and 55% are cash flow negative.

Lots more in their report, the index gives a good taste:

In conclusion, both Marathon and KKR see some of the most attractive opportunities in the history of credit markets. But they vary on the near-term outlook and when to deploy.

So, is 2023 going to be a Marathon or a sprint? Let us know your thoughts.

With less than 21 days to maturity of its €200m 1.375% convertible (veterans of German restructurings will know the significance of this number) 9fin decided it was time to check in the status of negotiations between Corestate and its bondholders.

On 3 October, a company spokesman had told 9fin:

“We are working intensively on a refinancing solution with a group of major noteholders and their advisors.”

“Our aim is to be ready for a noteholder meeting based on a joint proposal for a resolution in the next upcoming weeks,” they added. “As soon as we can make concrete things available to the market, we will do so with the usual diligence.”

This at the time seemed a little optimistic to 9fin’s sceptics. No mention of restructuring despite the bonds trading in the 20s, a refinancing clearly wasn’t the answer. After all, with its mezzanine funds gated, AUM fast disappearing from its real estate funds, and its debt funding arm suffering from a sharp slowdown in activity, their situation was dire.

It is worth highlighting at this point we were highly critical of the German Real Estate concern and its business model a year ago (when its bonds were in 80s).

As Denitsa Stoyanova perfectly summarised on 11 August, Corestate only finally got real about its long and arduous decent, after the release of its Q2 22 numbers. We concluded at the time:

“We feel that sufficient and timely new liquidity can only come from external sources. However, it will be a tall order at this stage to convince bondholders to lend into a business with substantial doubts on future earnings potential and a funding model which may be irreparably broken. Fresh equity from current shareholders appears unlikely given the miniscule market capitalisation and dilution fears from a likely debt-for-equity swap.

Corestate will have to be run for cash while it seeks to convince bondholders that it still has a place in the German RE lending landscape and can still fund itself competitively.”

We would have thought that by end-October some form of standstill or forbearance agreement would have been announced by the company to allow time to work on an orderly solution.

Our reporters had heard second-hand the shareholders were at odds with the bondholders, using the threat of insolvency to push them into taking a sharp haircut and debt extension, without having to give up their equity.

This was confirmed in the past few days, as detailed in Bianca Boorer’s piece earlier this week. After failing to reach an agreement with the company on 2 November 2022, a few days later on 5 November the bondholders released the company’s proposal and their counter on German news agency pressetext after Corestate failed to cleanse the information on its website.

The release said that on 18 October 2022, “certain members of the ad hoc group entered into a confidentiality agreement with the company in order to conduct due diligence and negotiate the key terms of a financial restructuring of the notes. On the same date the ad hoc group provided an updated proposal to the company, which was contingent on the appointment of a Chief Restructuring Officer (CRO).”

They added that “during the same week a group of certain potential investors (equity investors), some of which are shareholders of Corestate provided Corestate with binding equity commitment letters for a €45m injection, which also included terms for an amendment of the bonds.”

The ask for bondholders was to reduce their debt from €500m to €100m, with up to €33m from planned disposals, and 50% upside sharing in proceeds from repaid bridge loans and owing mezz fund fees. No equity was on offer.

Bondholders had countered with a proposal whereby they would receive 81.25% of the group’s equity in return for the same 80% haircut. They were willing to provide €25m of new super senior notes to plug an expected liquidity gap.

The bondholders believe there is a conflict of interest with CEO Stavros Efremidis having a 10% stake. They feel he is not acting in the interests of the company and should be removed and replaced with a CRO.

The company, on the other hand, says the CEO has skin in the game and only he has the financial capacity to save the business and jobs.

A business plan (said to be conservative) with projections were released alongside the term sheets. Under the company plan, the expectation is that EBITDA will be negative until 2024, and will be just €19.2m in 2026. In the meantime, there is €15m of additional liquidity required by mid-December, with an additional €10m at closing.

The next steps include an extraordinary general meeting on 22 November to clear the way for the issue of a maximum of 200 million new shares, according to Borsen Zeitung. This will be followed by a creditors' meeting set for 28 November which coincides with the maturity of the 2022 notes.

There is limited grace for the company if they fail to secure an agreement by 28 November. Under the bond documentation an event of default occurs if the issuer fails to pay principal or interest within seven days of the relevant due date, so this gets you to 5 December.

So, Corestate is leaving it very late. Could it be the first high profile HY borrower to use the new Starug regime? Or will a last minute solution be found?

The liquidation analysis gives just 18.6% recoveries. The bonds are indicated in the mid-teens.

Takko restructuring negotiations are also proving to be tougher than expected. Management previously emphasised that November was their target date to tackle the maturities with a “sustainable solution.” But no clear solution is on the horizon despite several months of talks with super senior lenders and senior secured bondholders, writes 9fin’s Lara Gibson, who summarises the positions of the various stakeholders.

Schoeller Alibert is an interesting case study for some of us at 9fin Towers. What are the options on dealing with their 2024 bond maturity, given the bonds yield close to 20%? The Brookfield-owned company has faced a challenging 2022 — thanks to a perfect storm of resin price inflation, inventory buildup and the unlucky timing for their rental business launch. Net leverage rose by 0.7x to 5.5x during the third quarter. On Thursday, in its Q3 earnings release they outlined a financial deconsolidation plan which will separate the capex-intensive rental business outside of the Restricted Group. This would significantly reduce capex, boost liquidity and allow a return to positive cash flow and deleverage the Restricted Group over time. Time to rejig our assumptions and prediction. Watch this space.

Diebold Nixdorf’s restructuring plan borrowed some of the coercive elements of Keter’s A&E plan. But the ATM maker’s plan has been more successful. In a shareholder letter earlier this week, the company said that 97% of the term loans have entered into the transaction support agreement, with 83% of the 2024 notes onboard, and completion expected in December. As 9fin’s Emmet McNally outlines, the plan will improve access to liquidity to fund inventory purchasing. The restricted access had led to a deterioration in supplier relations, which has caused short-term supply shortages and DPO to increase from 80-90 days to over 100.

While we await details of Orpea’s transformation plan on 15 November, which reportedly has a €2bn new money need, two equity investors have written an open letter opposing the second conciliation with its creditors. As we reported its unsecured bondholders had split into two camps, with other groups likely to form from its private placements or Schuldschein debt.

Metalcorp bondholders are to host a call next week to present their final counterproposal to the company’s amend-and-extend offer. The 2022 SUNs’ advisors, German shareholder association Schutzgemeinschaft Der Kleinaktionare (SdK) and law firm DMR Legal, are also set to present high-level findings of the due diligence into the company they have undertaken since signing an NDA last week. Due diligence is expected to include a review of Metalcorp’s liquidity, business planning, and potentially an on-site assessment of the company’s Guinean mining operations. Metalcorp earlier said it hoped the sale of its Guinean bauxite stockpile, scheduled for November, would facilitate the repayment of the past-due bond.

GenesisCare’s sponsors have provided some remission after waiving early repayments of their bridging loans from the group’s sale of Australian cardiology business CardioCo. Maturities on the facilities were also extended from July 2023 to November 2023, with a further six month extension possible at the discretion of KKR and China Resources Group (CRG). This should give the company more liquidity runway, crucial as cash burn at the group accelerates, 9fin reported.

Ahead of moderating a creditor-on-creditor violence panel for a Simpson Thacher event next Thursday at Claridges, I’ve been looking at a number of up-tiering and drop down transactions, and the subsequent litigations. One interesting ruling is Boardriders, where a group of minority lenders secured a ruling from Justice Masley which according to a Shearman & Sterling briefing has left them with almost all of their claims intact. Interesting points were determinations on sacred rights, open-market purchases, and no action clauses.

The court refused to read into the docs the lack of sacred rights which prohibit lien subordination, which is at odds with a decision made in the Serta uptiering, which the same Judge had presided over!

Tech layoffs was another big theme of the week, with Elon Musk deciding that over 50% of Twitter employees should go, only to find out over the weekend, that some were essential and managers had to backpedal and try to rehire. But would you return if your boss told you that “bankruptcy isn’t out of the question”?

I’m sure the bankers who are stuck with the Twitter financing are delighted with that, but at least they didn’t live in Medieval Catalonia!

But FTX quickly took over, delighting some of my finance journalist colleagues at other shops. Many found easy targets, the CEO of FTX Constance Wang used to work at Credit Suisse in their risk management department, but left because it was too boring!

And finally, after scoring at least three goals in the past three matches, Brighton are at long last exceeding their expected goals stats, with Roberto De Zerbi, their new Italian manager already a folk hero, after defeating Chelsea and our old manager 4-1 a fortnight ago.

Villa could be our latest scalp on Sunday, and if results go our way, we could be in a Champions League spot when the Premier League goes into its World Cup break. Forza De Zerbi

Its going to be a tough time for tech employees, surely bankers can empathise:

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