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Debt Advisory Update

It’s now only 83 days to Christmas – unbelievable how fast this year is moving. 
Earlier this week, we advised Terra Firma’s Annington business on its £800m bond issue – while Goldman Sachs, Barclays and JPM led the bond deal, we advised Annington on its approach to credit rating agencies and lenders.  This represents “repeat business” for us, following our role advising Annington on its £500m loan refinancing last year, and demonstrates our ability to provide strategic advice across all debt markets.

Debt weekly image - 30 Sep
TL / DR: Evergrandé, Grilts and Bank Errors 

1.   Not so Evergrande

  • I mentioned Evergrande back in August: it finally defaulted on 23rd September and for a short while the markets were spooked by the possibility that this could be a Lehman moment for China.
  • With the Fed is backstopping the markets ($1.6trillion of reverse repo at 30-Sep), investors are right that this is not “another Lehman” in the same way but that doesn’t mean everything is going to be just fine.
  • Most of the debt of Chinese developers is trading at distressed levels (<80 c in the $) and together these issuers have $900bn of liabilities to financial creditors, customers and contractors.  That’s 6% of China’s GDP, and I don’t pretend that the list of issuers is exhaustive.  This will impact Chinese banks: ICBC is a big lender to Evergrande and currently trading at 0.45x book value which suggests there is some doubt about how it is marking its assets.  Just like the GFC in Europe / US, Reuters reports the strong banks will take provisions but the weaker banks will have to extend & pretend.
  • The best primer on Evergrande I’ve come across is this Odd Lots podcast and the best piece of how we got here is this piece by Marc Rubenstein.   I won’t try to compete but just note a few interesting debt points.
  • Evergrande was very inventive with its off-balance sheet debt and I have a few examples to add to my list of off balance sheet debt: non-consolidated JVs including guaranteeing returns for JV partners (Intu once did something similar with Cale Street); forcing suppliers and employees to buy “wealth management products” if they want to get their invoices paid (is this just supply chain financing like Greensill?)
  • The legal ranking of liabilities isn’t going to determine recovery for creditors: the Chinese state will decide who gets what and overseas bondholders will come last, even after Chinese equity investors.
  • I don’t think the parental keepwell agreements are not going to work – these were designed to be almost as good as guarantees but without needing to be registered and approved by China’s State Administration of Foreign Exchange (SAFE).  Some of Evergrande’s bonds were issued by offshore entities where the onshore parent promises to keep its subsidiaries solvent – this is a good explanation.  I think the Chinese government will rightly determine that these keepwell deeds were designed to circumvent regulations.
  • Despite not paying coupons on its bonds, there is not yet an Event of Default – Evergrande has 30 days to pay before bondholders can demand accelerate their debt repayment (and trigger cross defaults for all of Evergrande’s debt).
  • Evergrande is offering some creditors “payment” via its products including flats and even parking spaces, an approach that I think more borrowers should copy e.g. could Pizza Express have avoided default by offering bondholders a Sloppy Giuseppe?
  • Finally, is it “Evergrand” or “Evergrandé”?  Even the FT isn’t sure.

2.   Grilts

  • The UK finally issued its debut Green Gilt – a record £100bn of demand for a 12-year bond at 0.875%, which apparently was 2.5bp cheaper than “fair value” for this tenor.
  • The proceeds of this are “earmarked” for green projects as set out in the UK’s Green Bond Framework.
  • Green bonds are often criticised in that cash is fungible: even if Green Bond proceeds are allocated towards green projects, that just means the issuer can spend other resources on less environmentally friendly activity.  This is even more the case for governments: Gilt rates are so low and much of the Gilt market is owned by the Bank of England, so the Government cannot claim to be remotely capital constrained.
  • Moreover, I think there is a more fundamental criticism: if these Green Gilts make any difference to the world at all then it must be because the UK government does something different as a result of issuing them.  But if this is the case then it means that government policy is being determined by financial markets – which is not exactly democratic.
  • The head of the UK’s Debt Management Office Robert Stheeman was opposed to Grilts for a long time, worrying they could raise the overall cost of public debt financing if they fragmented liquidity in the Gilt market.  But the yield on these new Gilts trade is now about 0.05% lower than standard Gilts – if investors are willing to pay more for these Grilts then the DMO should just be taking their money.
  • The Govt is about to launch a retail version of the Grilt scheme, via a Green Savings Bond and it will be an interesting test of retail investors’ appetite for ESG if they are willing to accept a lower interest rate.

3.   Bank error in your favour

  • Citi is back in court to argue that it should be entitled to force investors to return the $900m that it sent them in error, which I wrote about earlier this year.  So far as I can see, Citi’s argument is simply “accidents happen”, and is supported by trade bodies like the Loan Syndications & Trading Association and AFME.
  • Citi’s argument seems to be that any lender which received the full amount of a loan which was trading at 20c / $ would not believe the borrower had simply repaid the loan.  But it’s going to have to prove that the lenders actually did think it was a mistake and just kept quiet, and proving what people think normally needs some written evidence – some sort of smoking email.
  • I’ve got some sympathy for Citi here and it is just unfortunate that this error happened in a situation where the creditors were already arguing that there had been a default.  The alternative view is that this happens much more often than becomes public – in which case the mistake was in Revlon unnecessarily antagonising its lenders
  • New loans now include provisions obliging lenders to return payments if the agent notifies them it was an “erroneous payment”.
  • Almost as evidence to show that banks make mistakes, AXA last week issued a correction to the terms of its 2041 green bonds as it had got the interest rate wrong by a factor of 100 so that the bond interest rate was 137.5% – as my youngest child tells me, percentages are hard.

UK Financings this week

  • Luceco signed a new £80m 3-year RCF to replace its previous asset-backed facilities, with NatWest, Bank of Ireland and Bank of China joining HSBC.
  • Ocado priced £500m of 5-year high yield, at just 3.875%, which was upsized by £50m in response to investor demand.  Despite this strong demand, the bond immediately traded down in secondary to 98.75-99.5.
  • Mitie repriced and downsized its revolver to £150m, while also extending for 4 years, after its successful integration with Interserve’s FM business.
  • Gresham House Energy Storage Fund put in place a new £180m loan, and abandoned last year’s plans to raise debt via retail “Power bonds”.
  • Everton FC is getting close to a new £350m private placement for its stadium redevelopment as reported by the Liverpool Echo.
  • In the bond markets, Annington priced £800m of 12- and 30-year bonds at Gilts +132 to 160bp and BAT priced €2bn of subordinated bonds at 3.125% and 3.875%.

Mike Beadle

Managing Director, Debt Advisory

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