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Debt Advisory Update

Evergrande had a better week, after paying its bond coupons at the end of its 30 day grace period – partly by raising more debt secured against a mansion on Hong Kong’s peak, and partly thanks to its the founder injecting some of his own fortune.  Turns out limited liability isn’t worth that much in China.

Debt weekly image - 5 Nov
TL / DR: Banks Behaving Badly, Equity Cushion, Mint The Coin

1.   Banks Behaving Badly

  • After almost 15 years of banking fines, I’m not sure this qualifies as ‘news’ but we recently saw some sizeable fines / criminal cases for NatWest and Credit Suisse.  We’ll come back to the “accident prone” Jes Staley another time.
  • NatWest pleaded guilty to money laundering, specifically handly vast quantities of cash from a high street jeweller: about £1m a week, which in £20 notes would be a tower the size of a fully-grown giraffe (source here, this may not be entirely accurate).  At its height, the jeweller was depositing £2m a day, which even in £50 notes is about 40kg.  The business apparently had a turnover of about £300,000 a week!
  • Questions are being asked why this case took 5 years to come to court and why no individual NatWest employees are being prosecuted.
  • Credit Suisse came out with its third stunning compliance SNAFU of 2021 (after Greensill and Archegos) – this time for the Tuna Bonds, where Credit Suisse employees colluded with Mozambique government employees to divert loan advances and bond proceeds as kickbacks / bribes.  Corruption in developing countries is nothing new, but the complicity of a major international bank is more unusual – a few CS employees received $45m in kickbacks, led by Andrew Pearse.  They are called “Tuna Bonds” as the $1.5-2bn proceeds were supposed to fund a new fishing fleet but in fact the 24 boats just rusted away in port.
  • As ever, Matt Levine has the best write-up noting that Credit Suisse appears to have been guilty of different actions, depending on which regulator you read: The UK’s Financial Conduct Authority sees this as a failure of due diligence; the US Justice Department sees it as Wire Fraud; and the Swiss FINMA sees it as a failure to report money laundering.
  • I’m not sure it’s a failure to undertake due diligence: Credit Suisse’s DD report correctly identified one of the middle men as “a master of kickbacks” (para 16 here) which I think should be a red flag.  It’s more a failure of controls and it seems like Andrew Pearse involved just enough people to get around the controls.
  • In passing, the whole thing appears to have been caused by a love affair between two CS employees who needed some money to set up a boutique banking business together; who says romance is dead?

2.   Equity cushion

  • We get asked quite often by colleagues / clients “what is maximum debt capacity of this business?”, usually when contemplating a leveraged buy-out structure and valuation.
  • The right way to answer this is to look at underlying business model, competitive advantage, cash flow generation – basically nearly all the elements that you would look at when completing an equity valuation.
  • Helpfully some years ago the US and EU regulators produced a guide to what they thought “sensible maximum leverage” should be – guidance here and here, but in short: max 6x leverage and should repay 50% of total debt within 5-7 years.  This guidance is still nominally in force, though under Trump the US regulator did say that he didn’t expect banks to stick it if they could manage the consequences (which worked so well back in 2008).
  • In any event, it was more honoured in the breach than in the observance and the “6x” rule drove much of the imaginative pro forma run rate adjusted synergised NTM EBITDA to ensure leverage came in at 5.9x.
  • The quick answer to the modelling question is “about 60% of EV for LBOs moving up to about 85% if you’re prepared to include pref shares / minority equity”.  This has the benefit of requiring the questioner to do their homework before coming back.
  • The idea here is that so long as there is a minimum “equity cushion” and validation of the enterprise value then lenders can be happy there is skin in the game.
  • The same thinking was behind EU regulators’ requirement that anyone setting up a securitisation should be required to retain some risk in the structure, by retaining 5% of value of the deal (more detail here).
  • (in the long history of unintended consequences, this is producing a sub-industry focused on financing the risk retention assets).
  • Anyway, I was reminded of all this when I saw that Tesla has become the first $1 trillion market cap borrower with a sub-investment grade rating (Ba3 / BB+).  While fanboys cheer the sale of 100,000 Teslas to formerly-bankrupt Hertz for $4.2bn, S&P remains concerned whether free operating cash flow will fall below 2% of sales.
  • Incidentally, I don’t think it’s coincidental that the value of this “deal” is connected to “420”, for more background to this cannabis reference see here.
  • Ocado is another example where the equity cushion is cited as credit support, with the recent bond deal marketed as “9% LTV”.
  • I also saw “equity cushion” cited as support for WeWork’s high yield a few years ago, so it doesn’t always work out – as Kames puts it here “equity cushions exist … until they don’t”.
  • Or to quote Matt Levine on this: “The credit analysts are supposed to be the cynical pessimists, while the equity investors are supposed to be eternal optimists. Why would the pessimists outsource their pessimism to the optimists?”

3.   A trillion dollar coin

  • The US Debt Ceiling may have been raised a little in October to almost $29 trillion but that is forecast to be high enough only until mid-December – “X Date” is not another Marvel film but the day that the US government cheques start to bounce.
  • Much of the discussion is focused on intricate Washington political negotiations and voting mechanisms, like one of the weaker episodes of The West Wing.
  • Deliciously, there is a clear legal way for Biden to overcome the debt ceiling once and for all, without any assistance from the Republicans: the US Treasury can mint a platinum coin of any denomination e.g. $1 trillion.  This is deposited at the Federal Reserve and will reduce down the US govt’s overdraft there by the same amount.
  • To be clear, the coin can be any size or weight – it is the designation of its value by the US Treasury that makes it worth $1 trillion.  I hope that they will choose something about 2 foot across, like a giant charity cheque.
  • That’s it: it’s completely legal and very much intended that the US Mint should make money from minting special coins, though revenues are normally only about $2bn p.a.  The only caveat is that it must be platinum.  From the US Code 31§5112 (k):
  • “The Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.”
  • Much as it seems a ridiculous way to resolve a dysfunctional political stalemate, is it any less absurd than shutting down the US government due to an arbitrary restriction on its issuance of bonds?  It also makes it very clear than the US dollar is a fiat currency and exactly how Modern Monetary Theory works.
  • This podcast has the complete guide, from Joe Wiesenthal of Bloomberg.
  • For now, Yellen prefers to try to negotiate with the Republicans but my money is that eventually someone will “mint the coin”.  Why not?  It’s more reasonable than Tesla’s valuation.

Recent UK Financings

  • Marlowe increased its RCF to £130m with NatWest and HSBC.
  • Big Yellow signed a £50m 7-year sustainability-linked loan with Aviva, with margins reduced if KPIs are met each year.
  • Aggreko managed to price the take-private financing for I-Squared and TDR – pricing needed to be widened by 100bp from launch and up-front fees (OID) increased, and the subordinated $ debt pricing at 8.75%.
  • Wood Group signed a new $1.2bn 5-year sustainable bank facility, showing the benefit of resolving many of its long-running litigation issues earlier in the summer
  • United Biscuits is out with a new £300m private placement.
  • Arrow’s take-private financing for TDR placed €640m of floating rate notes at E+462.5bp and €400m of fixed rate notes at 4.50%, with a sterling tranche pricing at 6%, much wider than the difference in government benchmark rates.
  • PHP announced a new deal with Aviva, consolidating some previous private placements, with a 15-year loan at 2.52%, with margin reductions being available if ESG targets are met.  PHP also extended a £100m RCF with NatWest for a further 3 years.
  • Synthomer announced a new $300m 3 year unsecured term loan for its acquisition of a division of Eastman Chemicals, provided by Barclays, Citi, HSBC, and Santander.  This may be taken out in due course by a new HY bond.
  • John Lewis announced a new £420m 5-year RCF with seven banks, with margins changing depending on performance against 3 environmental targets.
  • Knights increased its RCF by £20m to £60m, out for 3 years, with Lloyds joining AIB and HSBC.
  • Apex’s financing to acquire Sanne is out: $465m and €225m term loans, guided at L+375bp for the $ and E+400bp for the €, both covenant-lite.
  • SIG has priced a €300m high yield at 5.25% (rated B+ / B1) to repay private placements and bank loans that were very substantially amended during COVID last year.
  • Advent’s financing for its acquisition of Ultra Electronics is out: $855m and €475m at L / E+375-400bp.
  • Derwent, Smiths News and Electrocomponents have all amended their facilities to be based on SONIA alongside +1 extension options.  As a reminder, UK banks are very focused to change £Libor to SONIA by the end of this year.
  • CD&R’s financing for the acquisition of Morrisons is still awaited.  Perhaps this is being held up by the same issues that forced EG Group to abort taking on Asda’s petrol stations: suppliers were unwilling to take credit risk on EG Group, meaning Asda’s needed to raise another £500m of debt (priced at 4.5% - which is 1.25%pt more than the main deal priced in January).  CD&R owns Motor Fuel Group which was expected to take on Morrison’s petrol stations.
  • Tesco issued another Sustainability Linked Bond: £400m 87-years at G+110bp, which was 5bp inside their non-ESG secondary curve – more greenium.

Mike Beadle

Managing Director, Debt Advisory

Email Mike

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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