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Debt Advisory Update

Not for the first time, just when COVID was getting predictable, a new variant arrives to shake things up.

Debt weekly image - 29 Nov 21
TL / DR: OMG Omicron; Bossy Boots; League Tables 

1.   Credit not immune from Omicron

  • Credit markets were just as spooked by the emergence of Omicron as equity markets, with the CDS Crossover index of credit risk back to levels not seen since November last year, before anyone even knew the difference between Pfizer and Oxford AZ vaccines.
  • You may remember that the blow-out in Crossover was responsible for Bill Ackman making $2.6bn in March 2020.
  • Liquidity last week was very thin, with many issuers waiting for the narrow window between Thanksgiving and Christmas (which probably means 17th December for the credit markets).
  • Government yields fell sharply, with 10-year Gilts at 0.8% and 10-year US Treasuries yields back under 1.5%, even as the FOMC indicated it could accelerate tighter monetary conditions.
  • Bloomberg expects $35bn of US investment grade bond issuance next week but no high yield credit.  European markets are expected to be slower with €20bn of investment grade issuance.  In leveraged finance, there are 4 loans due to price this week and many issuers will be watching these deals to see if pricing needs to move.  No new corporate deals have launched so far but some which were announced last week are still going ahead.
  • Like a lump of food in the neck of a python, the £3.4bn of debt for CD&R’s acquisition of Morrisons is waiting to move through the markets.  Even before this latest news, it seemed possible that the lead banks could lose money on the deal.  As of close on Friday, Asda’s bonds are now trading around 5%, which is only just under the maximum yields that the bookrunners have guaranteed for CD&R.  Depending how this week goes, they may have to hold until January and cross their fingers.
  • For corporate loan borrowers, we would expect any lockdown not to lead to the same chaos as March 2020: if banks need to re-run covenant loosening and providing more liquidity then we expect them to execute this with less noise than the first time around, plus we are all now used to working from home.  But as before, banks are likely to provide only what is necessary which might make expansionary moves more difficult for heavily-impacted borrowers.

2.   Bossy Boots

  • October saw the 20-year anniversary of Boots’ decision to switch its pension scheme assets entirely into long-dated bonds.
  • Boots announced on 28th October 2001 that it had sold all of its £2bn of equities over a period of 18 months and bought AAA bonds with average maturity of 30 years, issued by supranational bodies like the World Bank and the EIB, at a yield of 6%, which was 1% higher than Gilts.  A quarter of the portfolio was index-linked.
  • The resulting reduction in risk enabled Boots to lock-in an actuarial surplus, fixing its annual costs at 10% of salary and reduce annual fund management costs by over 90%. 
  • In addition, fixing Boots’ pension scheme also facilitated KKR (and Stefano Pessina) in their takeover of Boots in 2007 (at the time, the largest LBO in Europe), as the schemes’ funding position meant the business could be leveraged with £9bn of loans without regard to the pension scheme.
  • Boots was just the first of many pension schemes to transition from equities to bonds in search of lower volatility. In 2001, 75% of pension fund assets were in equities and this is now only 20% (source: Hymans).
  • The simple rationale is that pension schemes have made some (unwise?) promises and their sole objective is to be able to provide these pensions: the trustees care more about potential shortfalls than any surpluses (which are not for its account anyway).
  • If a sponsoring employer believes that equities provide a means to outperform bonds then they should issue their own bonds and invest the proceeds in equities.  Somehow that strategy only seems acceptable when it involves the corporate increasing debt to buy its own equity.
  • Back in 2001, Lane Clark & Peacock took the opposite view: “a bond-only strategy is guaranteed to reduce shareholder value in the long term … because of the opportunity cost of not investing in equities, which have in the past generated much higher long term returns”.
  • Since October 2000, when Boots started to transition its assets, AAA supranational bonds have returned almost 1% p.a. better than the FTSE100 (with dividends reinvested) at a much lower volatility.
  • Repercussions of this decision are still bouncing around, with the UK universities pension fund (USS) facing criticism for being overly conservative, with Martin Woolf of the FT calling it “folly”.  Not surprisingly the architect of the Boots decision doesn’t agree.
  • Similarly contentious is the long-discussed breakup of BT into Openreach and a serviceco: BT’s pension trustees believe that the resulting smaller sponsor would be much weaker and so they would follow a more conservative funding strategy, which could accelerate cash funding from BT.

3.   The league table where being top carries a penalty

  • In 2009, the G20 established the Financial Stability Board to make recommendations for the global financial system.  One day it will be as well-known to conspiracy theorists as the Federal Reserve or the Bilderberg Group.
  • The most notable activity of the FSB is to publish an annual league table of Global Systemically Important Banks (G-SIBs) to identify institutions that could cause world havoc if they went under.
  • Many recipients of this email will recognise how banking league tables are more of an art than a science.  This is a good description of the sausage factory and this FT article describes the incentives that league tables generate.
  • The FSB’s criteria for determining G-SIBs are all about size, global spread, complexity, underwriting capability, etc. (more here).
  • This year JP Morgan, BNP Paribas and Goldman Sachs moved up a division, with JPM now standing alone at the top and BNPP now the biggest bank in Europe by assets.
  • You might think that, just like being #1 in M&A or capital markets transactions, banks might also celebrate being identified as being critically important for the global economy.
  • But there is a genuine cost of being high in the league table: banks must hold more capital with the move for BNPP increasing its minimum equity capital by €3.5bn.
  • To be clear, BNPP currently exceeds its minimum ratios by some distance but still maybe it wasn’t a coincidence that BNPP last week kicked off the $15bn sale of its US retail bank and also sold some pref equity to further boost its ratios.
  • A few years ago, the IMF called out Deutsche Bank, Credit Suisse and HSBC as being the biggest risks in global banking, which was felt by DB to be a little unfair and subsequent IMF reports have not identified banks by name.
  • All in, this G-SIB league table doesn’t feel like one where you need to be top, although I think it might feel worse to be left out entirely.

Recent UK Financings

Private placements and bonds.

  • Mitie completed its refinancing with a private placement at 2.94% for 8-12 years at a credit spread about 200bp, demonstrating its rehabilitation over recent years.  Pricoa and New York Life provided the funding as a forward starting commitment from December 2022.
  • Ibstock refinanced with a new RCF and a 7-12 year private placement at 2.19%, representing about 120bp credit spread.
  • IG Group completed its refinancing with a debut £300m bond for 7 years at 3.125%, a spread of 245bp over Gilts.
  • TP Icap also issued a new bond this month, £250m for years, a spread of 205bp over Gilts.
  • Pinewood came out with a new 6-year bond at 3.625% which is a spread of 292bp to Gilts.  This is high for a BBB but reflects the high leverage (9x EBITDA) and private equity ownership.
  • B&M announced a new 7-year £250m high yield bond at 4%, at the tight end of guidance.
  • Derwent announced a new 10-year sustainability linked bond: £350m at 1.875%, a spread of 100bp over Gilts and much tighter than the 130bp guidance.
  • RAC priced £345m of 6-year high yield bonds at 5.25%.

Loans

  • Urenco signed a €500m 5-year sustainability linked RCF with margin steps up and down on achievement or not of ESG KPIs.
  • Ultra closed its financing backing Advent’s takeover, with a slight move of funding mix from EUR to USD.
  • 3i Infrastructure priced £400m sustainability linked RCF with a 3+1+1 maturity and £200m accordion.
  • Warehouse REIT exercised its £20m accordion to increase its bank facilities at 200-220bp margin.
  • GB Group refinanced alongside its £547m acquisition of Acuant with a £175m 4-year RCF with Citi, HSBC, Lloyds, Silicon Valley Bank and Bank of Ireland, priced at L+175bp (pro forma leverage 2x).
  • MIP refinanced its acquisition of French Connection with a £25m ABL from Gordon Brothers and Aurelius Finance Company.
  • Reach increased its RCF to £120m from £65m for 4 years.
  • LXi REIT increased its RCF by £65m to £230m for 3 years, with Barclays joining Lloyds and RBS International, paying SONIA +155bp.
  • NewRiver REIT extended its RCF by one year and reduced it by £90m to £125m.

Mike Beadle

Managing Director, Debt Advisory

Email Mike

Disclaimer 

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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