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Numis Three things About Debt 11 January 2023

2022 was a year when we had 3 PMs, 4 Chancellors, 2 Monarchs and no elections.  But 2023 has started with a bang, with a right royal family feud being played out in public; my kids need to up their game, as their fights have never even made local TV. I recently read The Daughter of Time, a great murder mystery about Richard III (once voted the Best Crime Novel of All Time).  The William / Harry saga has a long way to go before eclipsing the Plantagenets with Edward IV eventually executing his brother George but let’s see if the 2020s continue to surprise us …



Debt advisory image

Numis chart - Jan 23

1. Have debt markets done anything interesting yet this year?

Rates – mostly lower:

US, UK and European government rates moved up 50-80bp during December but have recovered in January.  UK and US 10-year government rates are roughly where they were before Kwasi stood up in September (both 3.5%), with German yields holding higher over the past 4 months at 2.25%

Looking back at the “Moron Premium”, as coined by the FT, since 1 September UK 30-year rates have risen by 273bp over the last 12 months, compared with just 160-200bp for the US, Germany and France

  • Future Base Rates (derived from forward curves):
  • UK: peak still 4.5% this summer, with maybe a 0.25% cut in Q4
  • Europe: more hawkish, with the peak now 3.36% in July with cuts unlikely this year
  • US: peak now 4.94% in June but then cuts of 0.75% later this year.  This seems unlikely to me …

Credit – much better

  • Investment grade spreads have tightened by about 30bp since November, and European high yield spreads are about 50bp tighter – mostly this week
  • The UK continues to be the laggard with Sterling High Yield bond yields still about 10%, about 2.5%pts more than Europe

More importantly, European debt markets are open, with 25 non-financial corporates launching EUR deals totalling €18bn.  We’ve even seen some Sterling, from Credit Suisse which raised £500m 3-year bonds at 7.75% (which, while expensive for a bank, is an improvement on the 9% is paid in October).  National Grid issued £400m at 5.273% (G+140bp) 

We’ve seen more corporates hedging interest rate exposure, sometimes through buying caps.  For example, The Restaurant Group has bought 3-year caps at 0.75% over £125 – we estimate this cost maybe £12m up-front, and Fullers entered a 3-year collar over £60m (3.1 to 5%, no cost)

In private equity world, practice is more mixed: Upfield (Flora) bought 18-month caps over 25% of its €6bn debt.  But Constellation Auto (WeBuyAnyCar) remains resolutely largely floating, stating recently that it “does not consider fixing interest costs to be economic at this time”

Anecdotally, we believe that only about half of private equity companies have any hedging in place, though we expect both borrowers and lenders to increase this.  New deals are likely to have a hedging requirement, just like the old days

Our view: it feels like inflation is becoming embedded, at least in the UK, not least because of pay pressure from widespread strikes.  But financial markets don’t reflect this: UK inflation swaps are 4.5% for 1-year and 3.8% for 5-years – both far lower than they were at the start of 2022.  Markets are even more bullish on US inflation, with swap markets pricing inflation below 2.5% by June (p27) and below 2% by December 2022

If inflation is more persistent than markets expect then interest rates will be higher for longer, and hedging future interest rates will become more expensive than today.  So hedging now wouldn’t look too stupid (averaging in will further reduce timing risk)

2. What’s going on in leveraged finance?

It’s easy to over-focus on leveraged loans, high yield and direct lenders.  After all, isn’t it mainly just private equity-owned businesses which finance themselves this way?

But even more lowly-leveraged public businesses are impacted:

  • The private equity bid: either to take-private listed companies or as competition for acquisition targets.  A lack of leverage finance means private equity is having to adopt other routes to deploy its “dry powder”
  • “Hung” underwritten financings: banks are still unable to sell some underwritten buyout financing which is preventing them from putting on new deals.  More broadly, these stuck loans are consuming capital, inhibiting new lending across the board by some of the global investment banks (though they will deny this)
  • A good example of this is Deutsche Bank which announced last week that the ECB required it to hold more capital requirement because of the risks in its leverage finance book.  There’s a great analysis by 9fin estimating this could double the amount of capital attributable to Deutsche’s leveraged finance business (in short: the extra capital applies to the whole of Deutsche Bank’s assets of which leveraged finance debt comprises only 1%) – which could make this business uneconomic.  BNPP also recently announced an increased capital requirement though it declined to explain what was behind this, even though earlier in the year the ECB wrote a “Dear CEO” letter warning on leveraged finance risks

There was a pre-Christmas flurry of deals that cleared much of the off-ripe deals clogging the shelves of the global banks:

  • Banks sold $2.1bn of debt backing Nielsen’s takeover by Brookfield / Elliott at 89 c / $ (so probably a loss of around $150m).  Just like with its Citrix buyout, Elliott bought some of the debt backing its own acquisition, at a steep discount – basically taking money from the underwriting banks
  • 888 refinanced some of the debt stuck with its lenders following its acquisition of William Hill.  This needed a yield over 12%, not mentioned in its RNS, though it did note that the discount was “funded by the banks” i.e. potentially >€50m loss for the underwriting banks
  • The final part of the €2.5bn debt backing CVC’s buyout of Ekaterra (Unilever’s tea business) was sold down at 82c/€.  All in, I think the banks lost c. €250m on this deal

Mostly this is leveraged financiers deciding that they would rather have one bad year of bonuses than two, and so they should take their pain in 2022

There is one large deal that remains as a terrible reminder of the excesses of early 2022: the $13bn of debt underlying Musk’s acquisition of Twitter.  The banks were rumoured to be trying to sell this down but bids were only 60c / $, which would mean total losses of maybe $4bn for the lending banks

So far this year there has been just one European High Yield bond, from Air France KLM, which priced €1bn of 3-5 year bonds at 7.25-8.125%, being 500-600bp over French government rates.  Unusually, Air France issues without a rating and probably pretends to investors that it is investment grade.  More controversially, these airline bonds are “green” – take a look at its Sustainability presentation here and see if you buy

  • We’re hearing that there are plenty more European High Yield deals being soft-sounded with investors for launch in the coming weeks

Meanwhile, financial sponsors are taking more risk to get deals done: KKR’s €2.3bn acquisition of April Group in November was initially all-equity funded, with KKR securing €950m of debt financing in last week from 5 credit funds and 3 banks.  Similarly, Sun Capital’s acquisition of K3 is (so far at least) all equity funded

Our view: there is still apparently $40bn of “stuck” loans on banks’ books, of which we think European deals are maybe 25%.  We think it will take 2-3 months to reduce the stuck deals down to just the tail end Charlies.  On the other hand, bankers and staff at private equity funds are absolutely incentivised to do deals, and competition always spurs a faster recovery.  Given all this, we expect 1-2 banks to break ranks in February and offer to underwrite a high quality new deal in February – but at a higher cost and lower leverage than financial sponsors have been used to, which may put pressure on valuations of private assets.  The other banks will then need to decide whether to get off the pot or …

3. Turning Private Equity Into Debt

You might think there is enough debt already in PE, with acquisition leverage at opco level averaging around 6x, but where there’s a will, there’s a way

Other ways of injecting debt into the equity portion have included

  • Subscription lines: delaying the drawdown request to LPs by borrowing from banks, secured against the commitment from LPs.  Sold as a working capital management tool, these have the handy benefit of boosting investors’ IRR when measured from capital drawdown to distribution.   It could also be viewed as just leverage at the LP level implemented by the PE fun
  • NAV borrowing: back-levering the equity at the fund level.  Rates here are juicer and have attracted private credit funds.  “Diversification is the only free lunch in finance” Nobel Prize-winner Harry Markowitz is reported to have said, and so I’m sure there is room for a little more debt at portfolio level, even if the underlying assets are optimally leveraged.  But (a) are opcos overleveraged to start with? and (b) is there enough diversification in a portfolio of 10-20 key assets to justify significantly additional debt capacity?
  • GP Funding – whether pref equity for the smaller funds or US Private Placements for the bigger funds, there is leverage for everyone

It’s not often you come across a completely new type of financing, so I loved the FT’s account of Collateralised Fund Obligations, a kind of CDO for private equity stakes (remember Anthony Bourdain’s explanation  of CDOs in The Big Short?)

An institutional investor takes a sufficiently diversified bunch of its LP stakes in private equity funds and puts them in a big SPV, then issues bonds against the cash flow streams that the funds will (should?) distribute

In a fun twist, Azalea (part of the SWF of Singapore) has found a way to sell these bonds to retail investors, with a cuddly animated YouTube video about the benefits of “gaining exposure to private equity through bonds”.  I am unconvinced - not a lot of upside in a 6% bond – particularly when listed PE investment companies are trading at 50% discount to NAV (e.g. Pantheon International plc)

But CFOs (i.e. Collateralised Fund Obligations, not Chief Financial Officers, the Cambridge Folk Orchestra or the Camps Farthest Out) have attracted private equity firms which are maybe disappointed with -27% equity performance this year, and looking for alternative ways to monetise their assets

  • On Boxing Day, Tikehau announced on 26 December a €300m Collateralised Fund Obligation of some of its interests in credit funds, apparently generating a €200m surplus over previously expected cashflows

If you want to know about “The Technicolor Dreamcoat of Fund Finance” then this guide is for you.  If you want to buy some of Azeala’s bonds then help yourself (not investment advice!)

UK debt deals in December

  • Unite Group has increased its sustainability-linked RCF to £600m (from £450m)
  • Superdry signed a new £80m facility with Bantry Bay, at SONIA + 750bp
  • Impact Healthcare, a British healthcare REIT, increased its facility with Virgin Money to £50m (from £25m) reducing its margin by 25bps and extending maturity by another 5 year
  • Jaguar Land Rover has refinanced its £1.45bn credit facility to extend out until April 2026 with a group of 23 banks
  • On The Beach has refinanced its facilities into a new £60m RCF introducing NatWest as a lender alongside Lloyds **NUMIS ADVISED
  • The Restaurant Group amended and extended its £220m TL and £120m RCF by two years 
  • Drax Group signed an additional £200m facility for 12 months on top of its existing ESG-linked £300m facility
  • Tyman has refinanced its existing RCF into a new sustainability-linked £210m RCF ** NUMIS ADVISED
  • Morgan Advanced Materials has refinanced its existing £200m facility into a new 5+1+1 £230m sustainability-linked facility
  • Numis upsized and refinanced its £35m facility into a new £50m facility at a lower margin **NUMIS ADVISED
  • Ashtead Technology has upsized its current £40m facility to £60m and extended by a further 12 months
  • Renew signed a new £80m 4-year RCF replacing its existing £44.2m facility
  • Safestore agreed a new 4+1+1 £400m linked to its ESG targets (NB. Not described as “sustainability linked” as the ESG KPIs are yet to be agreed!) 
  • LondonMetric signed a new 3+1+1 £225m sustainability-linked RCF to refinance shorter dated debt coming due
  • Costain has amended and extended its £125m RCF and £280m surety & bonding facilities by 1 year

Leveraged finance

  • Busy Bees (nursery operator) priced a €105m term loan B at an issuance discount of 92.5 and a margin of 375bp
  • 888 priced €332m tapped its existing high yield bonds at prices of 84-87, to yield about 11%.  It also subsequently priced $75m of loans at 85c/$.

Investment Grade Bonds

  • In November, Vodafone priced €1.3bn of 6 and 12-year bonds at 3.25% and 3.75%, a spread of just 70-113bp to swap rates, alongside a £600m 30-year sterling deal yielding 5.125% (G+180bp)
  • Also in November, Segro issued a 19-year £350m bond at 5.125% (G+175bp), almost no new issue premium


This briefing has been prepared using publicly available information and should not be relied upon for any investment decision. Numis does not make any representation or warranty, either express or implied, as to the accuracy, completeness or reliability of the information contained in this briefing. Numis, its affiliates, directors, employees and/or agents expressly disclaim any and all liability relating to or resulting from the use of all or any part of this briefing or any of the information contained herein. This briefing does not purport to be all-inclusive or to contain all of the information that recipients may require. The information contained herein is subject to change and Numis accepts no responsibility for updating it.

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