Azhar’s crunching credit – Spreads tighten so companies bring out stick but where is the carrot?

March was a great month for fixed income returns as credit spreads and government bond yields all tightened.

Key indicators

• The US 10-year treasury yield tightened 5bps during the month to end at 4.20%.
• Investment grade bonds outpaced high yield bonds. Global investment grade returned +1.2% and global high yield +1.1%.
• High yield spreads were 8bps tighter at 358bps, CCCs were unchanged, whilst Bs and BBs were 10bps tighter.
• Investment grade spreads tightened by 6bps to 103bps.
• The default rate fell by 0.1% to 2.8%: this breaks down as US 2.2% (-0.1%), EU 1.4% (-0.2%) and emerging market 7.5% (+0.3%). The gap between smaller issuers and larger issuers widened again to 3.4% from 2.9% as the small cap default rate was unchanged at 4.3% whilst large cap default rates were down 0.5% to 0.9%.

Credit stories

One of the themes we have been talking about in recent months is strong liquidity in corporate structures where equity value has receded. In these cases, this means that equity owners have disproportionate power relative to their current economic value and thus strong incentives to coerce bondholders into taking haircuts to the benefit of subordinated equity holders. We had three news stories this month – all in Europe – which are examples of this. The key to all these situations is identifying the sticks and carrots.

Intrum, the pan-European debt servicing company whose business is based around buying defaulted assets and then increasing their recoveries by getting the debt holders to agree payment plans, asked its own lenders to readjust their debt principal and maturity payments. Having made an asset sale recently the company had raised substantial liquidity and bond holders were surprised by the change in tone (previously the company had simply referred to using the proceeds to pay down near-term debt). Unusually, the management team attended meetings with investors where they took a slightly different tone. This surprised bond holders, who were seeing this as a threat to go into administration and that their attempt was for a more voluntary solution. Given the nature of this business, with strong asset value and covenants protecting debt holders, it seems unlikely that bondholders will just take voluntary haircuts on their debt without some equity upside; equally we find it unlikely that equity holders will want to go into administration as they will lose any economic value – a stand-off which we see as ultimately being in favour of bondholders (especially at current bond prices in the 60s). In other words, we don’t see a stick as punitive enough and the carrot also likely insufficient given the maturity profile of the debt.

Altice France, a telecoms and media business, surprised the market by announcing it would be requesting ‘creditor participation’ to reduce leverage in its business to 4x, implying a notional €10bn of debt reduction. With announced recent and proposed asset sales of €2.55bn, and unannounced but potential asset sales of an additional €3-5bn, the company is in the process of creating a ‘carrot’ of cash and with the recent designation of many of these assets as ‘unrestricted’ the company is also creating a ‘stick’ by which these proceeds can be diverted to whatever favours the equity holders. Altice France is a large and complex capital structure with senior and subordinated debt across bonds and loans and so the news led to a large drop in bond prices with short-dated bonds trading down 7-8 points to 90, senior secured longer maturity bonds falling 10-15 points down to the 70 level and subordinated bonds down 35 points to the mid-30s. We see these three camps of creditors as having very different drivers and incentives and expected outcomes will likely reflect this: shorter dated maturities to be insulated by their tenor (as a forced bankruptcy would require cash leakage which would be a likely breach of director duties, potentially opening up fraudulent conveyancing claims), and senior secured lenders by their asset value (consensus is that recoveries should be 60-80%). Which leads to the conclusion that subordinated holders will likely bear the most pain – with the question being how they are coerced ahead of their 2027 and 2028 maturities. With bondholder groups forming after this news, the ball is back in the company’s court and this will be a test case setting many precedents as the ultimate owner of Altice France also owns Altice International and Altice USA. An added quirk is that of the jurisdictional risk: France has an unusual and relatively untested ‘new’ updated version of its bankruptcy process (the Sauvegarde process was updated in 2021) – which historically hasn’t respected creditor rights in the same way as US/UK regimes – so it is unclear at this juncture whether that is a stick or a carrot.

Finally, taking its cue from Altice, we also had news that Ardagh Glass – a longstanding high yield market participant – was also considering a restructuring. With three tiers of debt, loose covenants and eye watering leverage this again was not a huge surprise. Here the sticks are relatively short maturities trading at discounts which suggest a likely restructuring and the carrots are some equity stakes in some associated entities so we do see a pretty significant likelihood of a solution which will involve creditors taking some significant impairments.

So, a fascinating month throwing up three situations all very similar to each other and likely to lead to some interesting news flow for the rest of the year.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.