The European High Yield market had begun March in defensive mode. Dealers marked down prices on significant fund outflows amid concerns of second order effects from the conflict on borrowers. Investors were defensive and short duration with higher cash levels (partly due to expected outflows and their valid concerns on rich pricing). Fund outflows have since abated and amid hopes of a conflict resolution, confidence was restored and encouraged some value seekers back into EHY.

On FinTwit this week, investors were complaining that dealer EHY offers don’t work, with buyers outnumbering sellers four-to-one. I’ve learnt the hard way that liquidity is always poor when everyone is leaning the same way.

Despite a lot of noise about the pain for EM investors, many Russian borrowers and entities connected to sanctioned oligarchs have met interest payments, Holland & Barrett being the latest to do so yesterday, according to a source close to the situation.

The Ruble hasn’t collapsed. Does this reflect Russian measures to support the currency, or ineffective sanctions, or hopes that a peaceful settlement will see sanctions lifted quickly?

After all, FX flows continue into Russia for energy payments, there are still buyers most notably from Asia (albeit at a deep discount) for their oil cargoes, but can they spend the proceeds? Conversely, what will happen to frozen reserves and assets abroad. Could investors try to seek legal attachments to them if they cannot get paid on their bonds by Russian borrowers or sanctioned entities?

As Sovereign debt legal experts Lee Bucheit and Mitu Gulati explain, this won’t be easy, and even if you think from a moral perspective that monies should be used to rebuild Ukraine, expropriation of assets puts you in a difficult legal position and would bring in OFAC and other counterparties. They will be keen to keep the $300bn of estimated Russian Central Bank frozen reserves held in accounts abroad as a bargaining chip.

For Ukrainian borrowers the situation is very different, either they are locked from making payments due to restrictions imposed by the Central Bank and/or their very operations are being severely affected. Investors appear minded to grant forbearance – witness MHP’s success in getting its consent solicitation in double quick time to extend the grace period for interest payments for 270-days. You can see why – imagine the international outcry if EM debt funds decided to kick off.

Agricultural peer, Kernel is doing the same, seeking lender approval to delay payments until end September, according to one distressed analyst. Other names such as steelmaker Metinvest are more problematic, given owner’s Rinat Akhmetov’s history of hedging his bets with either side, and his historical spats with Zelensky. Around 40-60% of capacity has been affected by hostilities, with two plants near Mariupol. And while there is a decent cash balance, declared dividends, a $1bn plant investment and bond buybacks could have stretched finances to the limit.

While advisors and some special situations funds are more geographical and asset class agnostic and are actively hunting for opportunities in the region, 9fin doesn’t directly cover EM (despite the authors past history and inclination). We are more focused on EHY corporates with direct Russia exposure such as Oriflame and Hilding Anders. Those suffering from second and third order effects from the crisis, are also on our radar, and many have also rebounded strongly. Trading updates and Q4 numbers for names such as Novafives and Kloeckner Pentaplast have shown issuers remained able to pass on higher input costs, with even some catch-up from the third quarter via time lags. In hindsight, selloffs were clearly overdone, prices have risen by more than 10-points from their lows.

But as detailed in last week’s Workout, the Russia/Ukrainian conflict is likely to have long-term repercussions with the macro picture worsening significantly in recent weeks. This is most notable is spikes in government bond yields, and the explosion in google searches for ‘yield curve inversion’.

Commentators have remarked on the remarkable accuracy of the US two-year/ten-year Treasuries yield curve to predict recessions. However, this time around there are more distortions, rates have been lower for longer, the Fed is behind the curve, and some would argue could still be well into tightening mode when growth slows, or even goes into reverse. This Macro Compass explainer is excellent.

Low coupon bonds are more sensitive to movements in interest rates (convexity and duration effects), which is moot for many HY bonds issued last year. Many have fallen more than 10-points in the past six months, but the majority of the move is often rate rather than credit risk related, hence our focus on spread-to-worst to assess stress.

The effect can be illustrated (and magnified) by Austria’s century (100-yr) bond issued in 2020 at 0.85%. The bonds hit a high of 133, but are now yielding 1.55%, a cash price of 65!

Achtung Maybe

Is it getting better?

Or do you feel the same?

Will it make it easier on you now?

You got someone to blame

Vladimir Putin’s insistence on being paid in roubles for Russian gas starting in April has led to worries that he may soon cut off energy supplies to Europe. G7 countries have rejected paying in local currency, saying this would be a contract default, and no doubt were concerned about the positive effects on the rouble.

In anticipation, German Economics minister Robert Habeck has now declared the first stage of the government’s Gas Emergency Plan which prioritises households over large industrial users.

According to Deutsche Bank’s Germany blog “In the first round, there would be targeted and announced shutdowns of specified individual large consumers, potentially for a long period.” Its analysts say that the main sectors affected would be chemicals, metal production, building materials and paper. In addition, the food industry is a large consumer of natural gas.

The second round of measures affects consumers from these large producers, such as the plastics industry, automotive suppliers and OEMs, mechanical engineering, electrical engineering, and the construction industry – already suffering from building materials shortages.

From our initial skim, here are few businesses likely to be affected:

Top of our list is arguably this year’s worst performer from primary, Cerdia, the Switzerland-headquartered cigarette filter maker. Owned by Apollo, the group priced $600m of 10.5% SSNs due 2027 in early February at 97, and its bonds are now trading at 87-87.50, according to ICE Data. The company says that it purchases a large portion of its gas and electricity needs based on fluctuating liquid market indices and uses commodity swaps hedging policy. According to its OM 18.4% of raw material costs are related to energy resources.

Its largest manufacturing facility is located in Freiburg in Germany, which does, however, have an associated power plant. During the year-ended 30 September 2021, 71.1% of the filter tow and 44.8% of the acetate flake produced was manufactured there. In its recent earnings release, management said that after the conflict began its Ukrainian customers shifted their production abroad with orders moved to Cerdia’s Freiburg plant. This is not surprising, as 85% of volumes from its Filter Tow Plant in Serpukhov Russia were sold outside of the country, including to Ukraine.

SGL Carbon says that it incurs substantial energy costs primarily for electricity, in connection with the production of its carbon fibres, specialty graphite products, and other graphite and carbon products. It has five sites in Germany and Austria. It had hedged 80% of its energy costs for 2022.

Progroup, the containerboard maker has two paper mills in Germany. It is also developing a new corrugated sheet board plant due to go into production in Q2 23. The company delivered an impressive performance in the fourth quarter, the highest revenues in its history and up 70% from the prior year. It is seeking to reduce energy costs via a new refuse-derived fuelled power plant, but it is still awaiting planning permission. It has a combined heat and power plant adjacent to one of its mills which it says reduces its energy costs.

Kloeckner Pentaplast, the medical and food packaging company has significant German operations. As our earnings preview outlines, as of February 2021, (from the most recent OM) the two German facilities represented ~20% of the company's total 842 kiloton production capacity. More information can be found here.

Energy cost developments are shown below and don’t consider forward curve evolution post the Q3 release (end-November). With the Russian invasion of Ukraine leading to a sharp spike in energy prices, investors will be eager to learn how much of this impact is covered through the recently negotiated pass-through program. European natural gas prices and Brent crude are up around 44% and 42% respectively since the beginning of December.

Paper Cuts

After a period of consolidation, energy prices were on the move upwards again this week, with European natural gas prices rising over 9% on Wednesday to close at €118.97/MWh, which is its highest closing level in nearly three weeks. One of the main affected industries is the paper and panelboard industry, which either uses natural gas or significant amounts of electricity in their production processes. Compounding the problem, Russia is a significant supplier of timber and bio-chips, according to trade publication MRW.

It could even cause a toilet- and tissue-paper shortage, prompting Cepi (the European paper industry association) to write to the European Commission this week, seeking to recognise the pulp and paper sectors as essential suppliers. With energy costs rising by up to 8x during the past 12-months there is grave concern about a “devasting and long-lasting impact” and the industry’s ability to continue operations in Europe and stay competitive in a global market, the trade body says.

In recent weeks, a number of paper mills have closed temporarily, due to high energy costs making production unprofitable, most notably for Pro-gest in Italy, which on 7 March stopped production at all of its paper mills of tissue paper and containerboard. According to EUWID, the machines resumed on 16 March, but only at half capacity. News of the closures caused a 20-point drop in its bonds from 88 to 68, with prices recovering to 76.6-mid this morning.

On Wednesday, their President Bruno Zago said “Pro-Gest Group, while making uses of highly efficient production processes, uses large quantities of natural gas and is therefore subject, like the entire paper industry, to fluctuations in energy prices on international markets which have registered violent and sudden increases since the second half of 2021.” He added that the crisis in Ukraine and speculative phenomena has meant that energy prices are 3x the cost of raw materials. The company is seeking to raise prices to offset cost inflation, but as Moody’s notes it will take time to fully recover higher costs. The agency now expects gross leverage to remain over 7x in 2022 and says that liquidity is ’weak.’

German peer Wepa €425m 2.875% 2027 SSNs were downgraded by Moody’s this week to B2 from B1. While less leveraged that Pro-Gest, it is likely to be in breach of its springing covenant, limiting access to liquidity, the agency reports. The notes had been under pressure in recent weeks but have stabilised around 85 since the release of a FAQ on 18 March, which we suspect is a compendium of investors enquiries.

Other paper names on our watchlist are Lecta, the Spanish coated woodfree printing paper manufacturer, whose €200m SSFRNs due 2025 are languishing in the mid-80s, its South African peer Sappi who appears to be fairing much better but has announced a raft of price increases of late, and Reno Di Medici, the Italian packaging cardboard manufacturer, whose €445m senior secured 2026 FRNs were issued at 98.5 last December, having recently dipped below 90.

We will be looking more closely at these and other pulp and paper names in the coming weeks.

I can’t believe it’s not better

Upfield (Flora Food Group) has left a bitter aftertaste for its bondholders and sponsor alike, since its carve-out from Unilever in 2018. Cumulatively, Upfield has spent over €750m on separation and restructuring under KKR ownership, compared to an initial expectation of a one-off spend of approximately €425m – comprising €200m to implement cost savings and initiatives, €45-€50m on restructuring costs and €175m on branding and marketing to reposition as a standalone business.

As 9fin’s Emmet Mc Nally says in his two part deep-dive report: “Separation and standalone costs have over-run by some margin with their dwindling influence in 2022 replaced by concerns of input cost inflation as a result of the Russian invasion of Ukraine. High restructuring (broad label) costs have weighed on cash generation and therefore leverage, with reported credit metrics gradually moving further away from marketed levels.”

Its junior bonds are now trading in the mid-80s, with leverage at around 8.7x (9fin estimates) at Q3, with deleveraging prospects limited ahead of an expected refinancing in early 2024.

If you are not a client but would like a copy of this two-part report, please complete your details here.

No accounting for haste

Yet more accounting delays for our stressed German Real Estate companies this week.

Adler Group announced that the special investigation from KPMG looking into allegations from short seller Viceroy Group, which had delayed the publication of its full-year results, would be postponed again until 22 April 2022. As previously disclosed, the investigation required further data to refute allegations on related party transactions and valuation differences on its development portfolio. This means that the FY annual report and financial statements for FY 21 will be released in the last week of April.

Curiously, Adler Group said that it had borrowed €265m from its Adler Real Estate subsidiary via an unsecured loan with standard market terms, with Adler RE able to demand collateral “in the event of a significant deterioration in the company’s financial circumstances.” It is unclear what the money need is for, it is however limited from consolidating its cash (proceeds from recent portfolio sales sit at Adler RE) by a lack of domination agreement, which may explain the loan. Whatever the reason, this and news that Vonovia is unlikely to make a full offer for the group, pushed its long-dated bonds back towards 80 and not far from previous lows.

Corestate Capital said that ongoing audit procedures will mean that the audited consolidated financial statements will not be completed by 31 March 2022 as previously expected. It had said in early March that following changes in senior management, auditors Ernst & Young “wanted more time to assess” the accounts at its Corestate Bank division, with Stavros Efremidis, the new CEO, saying during a bondholder update that “we couldn’t provide the full information that they asked for.”

Corestate now says that a major reason for the delay is a “renewed impairment test of the goodwill-bearing cash-generating units (CGUs) in the Real Estate Debt segment (Helvetic Financial Services (HFS). The goodwill being recognised totalled €520.1m on 30 September 2021 and if impaired it will impact depreciation and amortisation, says Corestate.

As reported, the group has disappointed bondholders by the pace of its deleveraging, amid concerns about the lack of transparency, which the new CEO says he is keen to address. Asset sales are key to hitting a sub 3x leverage target to enable a refinancing by late Spring. But the FT recently reported that its sale of Liverpool’s iconic Liver building could face scrutiny, as while the building is listed as under the ownership of Corestate, it just has 35%, with 49.9% owned by Everton FC owner Farhad Moshiri a long-time business partner of sanctioned Russian Oligarch Alisher Usmanov.

In brief

There was further progress on agreed restructurings for a number of our names this week.

Lowen Play secured a single-class creditor meeting for 28 April at its English Scheme convening hearing on 30 March. The sanction hearing is set for 5 May. There was no opposition to the restructuring plan, which sees debt maturities for the Germany-based gaming arcade operator extended until December 2025 and September 2026, and bifurcated into an Opco/Holdco structure. There is higher interest payable on the reinstated Opco debt, but overall interest costs will reduce slightly on an annual basis. In return for their consent and the lack of a deleveraging injection from the sponsors, bondholders will take ownership and control of the business. The €40m SSRCF will be repaid from cash on the balance sheet at completion. For more details clients can see our Restructuring QuickTake. If you are not a client but would like to request a copy please complete your details here.

Haya Real Estate has launched a consent solicitation to change the governing law of the notes to “facilitate the jurisdiction” of England & Wales to sanction a planned Scheme of Arrangement to implement its stressed A&E transaction. For more details see our Restructuring QuickTake, if you are not a client request a copy here.

Yell has announced that its restructuring has become effective on 30 March. The outstanding principal of its SSNs is now £65m with the maturity of the notes extended from March 2023 to 2027, with the remainder exchanged for equity. You can request a copy of our Restructuring QT here.

What we are reading this week

Our friends at Information is Beautiful have a great infographic on the Ukraine-Russian war

You cannot accuse Microstrategy of not doubling down, it is now using $205m of margin loans to buy Bitcoin (lets hope the current hoard are hypothecated). As Matt Levine explains these are subject to daily margining, but is just at a 25% LTV, with $820m of the crypto currency backing the loan from Silvergate Bank. If the LTV rises (prices of coin goes down) it has to put more coins into the account or pay an additional 0.25% of interest.

Philanthropy is not dead, we couldn’t believe our luck when we received this email this week:

My name is MacKenzie Scott legitimate EX Wife to Jeff Bezos Owner of Amazon and now second richest man in the world. I walked away with about 38.5 billion dollars worth of share in Amazon and till date the highest divorce settlement in history. Ever since I became so rich I have given away for than 20 million dollars in donation and charity. I have decided to donate to people in Europe and The United states this new year and your email was among the lucky winner to receive the sum of One million Euros. I have a bank set up in Luxembourg and USA for the purpose of getting this donation across to you.

To claim this sum send your full name, country and phone number to email:

Any finally, another great innovative product from Dyson (I received no commission for this plug)