LevFin Wrap — UK Blues Edition

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LevFin Wrap — UK Blues Edition

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13 min read

The UK’s capital markets lurched into chaos last Friday, and went from bad to worse earlier this week, with sterling plunging below 1.04 on Monday, and Gilts yields spiked, exacerbated by the levered exposures built up by the UK’s Liability-Driven Investment (LDI) funds.

The prime minister and her chancellor had parroted international events and Putin as the reasons for the demise of foreign confidence and the UK Blues, not down to their lack of due care. It was left to the Bank of England to try and revive it with an injection of Gilt buying.

No no he's not dead, he's, he's, restin'! He’s stunned

Facing big margin calls on long-duration levered Gilts (the 2073 linker is a particular duration hog), the LDI funds started selling Gilts across the curve, as well as dumping credit and anything else that could be monetised fast. For example, 9fin’s Owen Sanderson disclosed in this week’s Excess Spread that an asset manager was dumping £2bn of securitisations.

Sterling high yield is unlikely to have been top of their sell list — most bonds are already well below par so this would just crystallize a loss — but loss of confidence, currency decline and spiking interest rates do feed through to leveraged credit markets.

Plenty of sterling HY is directly exposed to UK consumer spending — think Stonegate or David Lloyd (pubs and gyms, the twin peaks of the leisure industry), while UK retail has been a dog for the better part of a decade.

Homebuilders Keepmoat and Miller Homes should be pushed in both directions by the UK mini-budget. Cuts to stamp duty, a tax on moving home, should be a benefit to these firms, but with mortgage rates shooting up and the withdrawal of hundreds of mortgage products, home purchasing activity seems sure to slow down.

Zoopla said today the “Housing market is slowly transitioning to a buyers market as higher mortgage rates set to hit household buying power by up to 28% and asking price reductions return to pre-pandemic levels.”

Together is a bond issuer directly exposed to conditions in the mortgage market — if vanilla High Street rates are pushing north of 5%, the specialist products where Together operates might price some borrowers out of the market altogether. The bonds have puked, with £380m 2027 PIK toggles now trading at ~70 (the biggest faller in sterling high yield this week) but it has no near term maturities, and refinanced its extensive ABS facilities earlier this year, giving it plenty of headroom to keep writing loans if demand is there.

Business profitability relies on the spread between the loans Together can write and the costs of its ABS facilities — the latter is also under pressure from the broader market conditions.

The UK chaos comes on top of existing stresses — energy cost and supply, and related products such as carbon dioxide were already putting pressure on some credits. Boparan, which has been only a short step ahead of creditors for the past several years, is facing pain from the CO2 cost, while this is also set to hit the pubs and brewers. The Chicken King’s bonds fell another five-points this week, leading to a spread widening of 164 bps (19.5% STW).

Retail Therapy

Supermarket Iceland’s freezer-heavy business is exposed to electricity costs, now capped by the government, but just for six months and with few details are yet available about how this will flow through to the company. Their 2028 bonds are back down to YTD lows in the mid-60s, to yield 13.25%.

Matalan is vulnerable to changes in FX rates, in particular to the US dollar in which it buys most of its stock from the Far East. It has suffered from rises in shipping costs and supply chain delays. It is hedged at £1/$1.37, but this rolls-off in February.

Earlier this week, the company confirmed that a sales process had been launched, with an ad hoc group (AHG) of SSN lenders offering to provide £200m of stapled financing to interested parties. To allow time for completion, they committed to extend the maturity by six-months. Alternatively, they have committed to a recapitalisation transaction “which will result in a material reduction of Matalan’s debt” with an extension from January 2023 to September 2027.

See our initial review piece here, with more analysis is available in today’s Friday Workout.

Sudden Debt

Bonds from UK debt collectors Lowell and Arrow Global were hit hard too, down almost 10% on the week. Rising levels of UK consumer distress should be good news here, giving larger portfolios available to purchase at more attractive prices. But their sector suffered from a re-rating this week after Swedish peer Intrum announced a write-down on some Italian secured NPL portfolios, cutting estimated remaining collections by €138m-€156m. 9fin’s Owen Sanderson notes that this raises fears over the broader performance of Italian NPL portfolios many of which have been underperforming against original expectations.

The debt collection firms have been expecting a major NPL wave to hit for at least the past two years…perhaps 2023 will be their year?

But fundamentally, the business of the debt collectors is about valuing a stream of cashflows stretching out into the future, as these loans are worked out and collected over time. A big rise in UK rates means these cashflows are less valuable when you NPV, and hence, in part, the bonds falling.

Calling International Rescue

UK high yield also features highly international UK businesses without much in the way of sterling bonds — Jaguar Land RoverAston MartinAggreko or Rolls Royce for example.

These firms have an element of natural hedging, in that they generally issue dollars and euros, while earning also in a combination of international currencies. To the extent that their HQ costs and UK staffing are significant, these names could be net beneficiaries of a declining sterling exchange rate. In the case of JLR, though, it hasn’t stopped the bonds selling off substantially — in its OM it says revenues are particularly sensitive to the US dollar, Ruble and Yuan, while most of its input costs are in Euro.

Aston Martin, however, is a special case thanks to a $200m tender offer launched on Thursday, funded by a rights issue and targeting its 10.5% 2025 SSNs (callable at par) and 15% 2L 2026s (at 105%). The UK sports car manufacturer is committing somewhat less than the ‘roughly half’ of the proceeds to the buyback as previously indicated — to be conducted via a Dutch auction process — with a 4 October 4pm deadline.

The bonds had rallied significantly since Aston first flagged its intention to buy back the bonds in mid-July. The second lien are up from around 90, to plateau around 110, and the first lien rose from 90 to 105, but drifted since, to 97.5-mid currently. This might affect the dynamics of the buyback, 9fin’s analysis of the options when the plan was first announced here.

Elsewhere in High Yield Secondary

In addition to the above, there were a number of issuers with their own specific news which caused sharp movements in their bond prices.

Tullow Oil’s bonds dropped over 15 points, after Capricorn Energy decided to accept an alternative bid from Israel’s NewMed. The UK-headquartered E&P producer says it is still on track to refinance, with debt/EBITDAX to drop below 1.5x at year-end, but with its SSNs and SUNs now yielding 17% and 33% respectively, the bond market may need some convincing.

Orpea 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 which are likely to intensify. Their bonds have hit fresh lows and are well in distressed territory — the 2% 2028 SUNSs yield 13.5% (56.25-mid) and the shorter-dated 2.625% 2025 SUNs at 22.5% (64.25).

Morrisons posted a disappointing set of Q3 results this week, with its EBITDA for the 13-weeks to 31 July halving from the same period a year earlier. It blamed unprecedented inflationary pressures and said as a foodmaker (50% of what it sells) as well as a retailer it feels the effects more than its competitors. It’s £1.075bn 5.5% 2027 SSNs dropped almost three points on the news, and are today indicated at 78.12-mid to yield 11.25%. It’s nearest comp, Asda 2026 SSNs are 100 bps back at 12.25% yield (75.75-mid).

Synthomer issued a short trading update yesterday in which it said that full year EBITDA would be 10-15% below previous expectations. It blamed high inventory levels of medical gloves and reduced demand, together with reduced demand in construction and coatings end markets. The shares of the UK-based polymer manufacturer fell by 34% and its bonds fell by almost six points. The €525m 3.875% July 2025 SUNs are currently 82.25-mid to yield 11.6%.

Ceconomy bonds are still trying to find a floor after a sharp fall last week on a ratings review and the loss of its CFO. The German consumer electronics retailer’s 2026 SUNs are now well into distressed territory, falling another 2-3 points this week to 57.25-mid, around 18% yield.

High Yield Primary

With the unprecedented market moves spilling over into non-sterling markets — the iTraxx Crossover flirted with Covid-crisis wides and almost breached the 700 bps barrier on Tuesday — it was not surprising that high yield primary was relatively quiet this week (though busy by 2022 standards).

The €500m 5NC2 SSN for Verisure, the H&F-owned security and alarm company, was probably one of the few names that could have come in such turbulent markets.

It’s something of a market darling, and the deal is significant as the first large cap conventional high yield refi since the Russian invasion in February. All the other supply has been event-driven in some capacity — new LBOs, add-ons for acquisitions, continuation funds or similar — or privately placed.

The new deal is to refinance the €200m 3.5% 2023 SSNs. Clearly 9.25% is worse than 3.5% and it’s also a good way back of the 8.5% yield on the company’s existing €1.15bn of 3.25% 2027 SSNs (callable at 101.63) from February. That’s trading in the low 80s (after cheapening up a couple of points on the new deal launch), so there’s something to be said for the convexity versus a new par issue, but it’s also reasonable to come, in a week like this, with a healthy new issue premium and a constructive attitude to pricing.

The deal duly popped to 101.25-101.75 in secondary, so perhaps hindsight would say there was something left on the table, but it’s an understandable hedge against the conditions. The notes have drifted lower lately, currently 100.75-101.50, according to one buysider.

House of HR is also in the market with a €425m SSN, a deal financing Bain Capital’s purchase of the staffing and recruitment firm. It’s the second part of the financing to hit the market, following last week’s launch of the TLB and second lien leg.

But four days on, we are yet to see price thoughts for the SSNs, and there must be a risk, that similar to Inetum the House of HR bond could get pulled and the loan piece be upsized. We have reached out to the leads, and while the first lien loan priced predictably wider than the existing — at E+575 bps and 92 (see loans section for more) — we have yet to get a response on the SSNs at time of writing. For comparison, price talk on Inetum’s high yield portion was at a lofty 10.25-10.5%.

Leveraged Loans Primary

Markets are watching if further global financial instability could arise from volatile UK Gilt moves. No one was therefore surprised that not a single new loan syndication was launched in Europe this week. Deals that did price this week either had to downsize or widen their price talk to get syndications over the line.

Netherlands-based synthetic grass manufacturer TenCate Grass remains the last deal with live commitments, which are due next Tuesday. The company is in-market with a €274.3m add-on TLB to fund the acquisition of the US peer Hellas. Its loan is guided at E+500 bps with an OID indicated between 92 and 93.

Buysiders polled by 9fin praised that overall, the synthetic grass market is growing. The sector benefits from positive tailwinds, as climate crisis imposed droughts should support demand when clients switch to artificial grass. However some do not see the transaction as leverage neutral (as presented by the management) and are not giving the benefit to all adjustments made to EBITDA. Underperformance and pure debt-funded growth does not sit well in uncertain times.

“It is not terrible by any stretch, but we declined as we thought leverage is too high because of underperformance,” said one buysider.

Concerns also persists with big execution risks around Hellas. It’s not a small bolt-on acquisition, but closer to a merger which almost doubles EBITDA. Watch this space for more detail in our upcoming preview on Monday.

Moody's seems to share buysider worries, it changed the business outlook to negative in May 2022 on the back of the acquisition, expecting the move to delay deleveraging. Luckily for TenCate Grass the deal closed in May and is already fully funded. So, if the lead banks do not want to succumb to a deeper discount demanded by the market next week, they could hold the loan on their books a bit longer, and attempt to wait out current volatility.

Following a mixed reaction from buysiders, Spanish-headquartered KronosNet has cut its initial €450m 2029 TLB by €50m to price at widened OID 92 (from 93) while the margin stayed unchanged at E+575 bps. The transaction funds the combination of business outsourcing and call centre firms, Italian Comdata and Spanish Konecta.

The company also made documentation concessions to get its debt package through — including doubling the length of its MFN lock-up as lenders get comfortable with the growing role of TLAs in syndicated deals.

The syndication MFN provision was increased from six-months to 12-months at 92 on both the TLA and TLB, according to buyside sources. KronosNet follows Inetum last week, where underwriting banks agreed to lock up its €533m TLA tranche until January 2023. With new syndications dynamics and unstable markets, TLA lock ups are probably here to stay on troubled syndication trying to get done.

Analysts previously told 9fin they were disinclined to play the deal, mostly due to Comdata’s chequered past, after the company restructured last year.

A chunky equity cushion and eye-catching pricing, however, kept some buysiders keen compared to other loans in market. “Others will ratchet down quickly to a 4-handle, but even with a ratchet, this one is going to stay happily in the 5s,” said one buysider. “That’s the kind of pricing we’re needing at the moment.” Read our preview of the deal here.

Lenders described the Belgian staffing provider House of HR as a stable, “straightforward” credit in 9fin’s preview. Nevertheless, the macroeconomic environment worried some buysiders, who question how a recruitment business will perform in a downturn. A punchy cap structure, including pumped up leverage has also shaken the credit’s previously attractive foundations.

The first lien tranches are split into a €1.02bn TLB and €125m delayed draw piece, priced at E+575 bps and 92 OID today (30 September), down two points from 94 guidance. A €310m second lien leg guided at E+900 bps with a 94 OID will price subsequently. By the time of the publication there was no update on the €425m of senior secured notes (no price guidance). Last minute documentation changes also involved MFN protection, although again details were not available by the time of publication.

Leveraged Loans Secondary

The European secondary loan market was down 2-3 points across the board. Unsurprisingly most pain was felt for companies with a UK country of risk, according to one portfolio manager, one CLO analyst and one trader.

Market players were already feeling shaky about UK paper prior to the mini-budget crisis.

“We have been gradually selling off UK risks. We got out of Iceland and Asda, but more because of the declining consumer demand than FX worries,” said the CLO analyst. “You could see for a while that the UK will enter a recession on the tail end of this or next year, this just all made it much more certain.”

Of the top fifteen loan decliners in Europe, five had the UK as their country of risk

EG Group and Asda were the most affected UK issuers, seeing their loans fall 5.4 points and 5.6 points, respectively.

“Interestingly a lot of the consumer UK sterling-denominated names aren’t doing too badly because they have such a deep distressed bid,” said a trader. “For example, Stonegate, as soon as it hits 90, loads of distressed investors want that.”

Road to redemption

However, for those with upcoming maturities next year the latest round of price deterioration complicates the path to refinancing as their interest costs rise yet further.

The market was hit this week by some technical redemptions from loan funds, but companies were mostly marked down rather than truly sold, with buysiders saying it is too early to see if there is any specific real impact in their portfolios.

“We can’t really judge if there is gonna be real impact on performance yet, but the sold-off sentiment was a huge hit and there is no bid for loans, and no CLO creation,” said the PM.

So, the pricing discovery theme of 2022 continues as overall market sentiment further deteriorates.

“The market is busy, there is an ask but not at a practicable level. We see a lot of mis-priced risk in the market,” said the trader. “We saw Flora [Upfield] asking price at 50 but has traded at 55 where it actually could be sold.”

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