Friday Workout - Glide Paths Sending Out A Distress Signa (L) (9fin)

29/04/2024, 17:48 Friday Workout — Glide paths; sending out a distress Signa(l) (9fin)
SIGNA Development 10:30 1st December 2023
9fin-Distressed Friday Workout 9fin-Feature
Friday Workout — Glide paths; sending out a

distress Signa(l) (9fin)
10:30 1st December 2023 • 16 min read
Chris Haffenden | chris@9fin
It’s the time of the year when forecasts from research houses land in journalists’ inboxes, and
we turn our attention to writing reviews of the year and next year outlooks for our respective
beats. But the danger is that, while putting together these divinations, big events can happen
and economic facts change to such a degree that the reports are obsolete on release.
I suspect analysts were working on their economic forecasts for weeks, if not months. But
from an economic and markets perspective, the narrative shifted dramatically in November.
With one day to go, Bloomberg’s global bond aggregate had posted its best month since
December 2008, and the US component the best since May 1985.
As one commentator aptly put it, the recent sharp rally in bonds appears to be a “duration
play for a soft-landing world”.
Markets are now pricing in 2024 rate cuts as early as March, and a full percentage point on
both sides of the Atlantic by year-end. Risk asset spreads are at the tightest levels in over a
year. Is it really just over two months ago we had the rates puke?
Most forecasters agree interest policy rates have peaked but there is a huge difference in
glide paths on growth (as the Economist shows below) and rates. Deutsche Bank is now the
lone voice (among banks) for a US recession, calling for a hard landing in the second half. It
cautions US HY leverage is as high as it has seen outside of a recession since 2005, with
non-cyclicals particularly at risk.
https://9fin.com/news/eb65008b-7d6b-4c7b-bdf7-3711d81d615e 1/14
BofA is another research house in the more bearish camp. It says don’t confuse the lagged
impact of higher rates for no impact. But it then goes on to say the US HY market is of higher
quality than historical levels, with most issuers having “levers to pull and glide their debt level
to where they are comfortable with the new coupon”.
The bank’s analysts caution the residual (34% of US HY), and mostly private, issuers will face
difficult decisions whether to cut deep into the businesses or deep into their debt. This is
more prevalent in loans (73% private) and “completely dominates private credit”. It adds that
net downgrades are likely to be around 5% with the triple-C bucket doubling in size in 2024.
As a side-note on Private Credit, looking at Lincoln International’s EU insights Q3 report, while

covenant defaults remain lowish for the private credit deals its advisors track at 3.9%,
globally they saw 550 amendments since the start of 2023, which is around 15% of the
private credit valuations they had performed. The cadence is increasing too, with 2021
vintages particularly prevalent.
Deutsche analysts are defensive on HY returns, forecasting sharp widening of spreads in a

no landing, and hard landing scenarios in both US and Europe, with limited room to tighten on
a soft landing (not their base case, but seemingly base-case for everyone else):
In Europe, Deutsche forecasts a shallow recession in the first half of 2024, and credit spreads
to be range-bound, before widening sharply as the US growth backdrop deteriorates in H2 24.
“Tight spreads on the back of strong technicals, mounting maturity walls and the increasing
pass through of higher interest rates warrant caution when it comes to HY-rated Non-
Financial Seniors — more so in Bs than BBs.”
It is worth noting, despite the recent tightening in LevFin spreads, downgrades and defaults
are already rising, particularly in the US, with corporate leverage elevated historically.
And while the US LevFin maturity wall in 2024 is largely dealt with, the proportion of the
market due in two and three years is historically high, with 9.2% of the total coming due in
next two years and 22.3% in three years. In Europe this is even higher at 12% and 30%,
illustrated below:
The main reason is issuers remain reluctant to refinance at current yields, with hope implied
that rates can fall sharply from here. Sub BB borrowers are particularly at risk if this fails to
occur — great chart from Deutsche on expected rises in interest rate costs:
And as 9fin’s distressed and restructuring team is well aware there has been a pick-up in
fallen angels (up €5bn since 2022 to €12bn) mostly coming from real estate. But this hasn’t
affected wider EHY market dynamics given little net supply (save HY hybrids and bank senior
paper) resulting in strong technicals for EHY spread compression (as fund redemptions
wane).
However, Deutsche notes there is €25bn of IG notional very close to being downgraded to HY
(of which €9bn is real estate). The tailwinds are likely to be less strong in 2024:
Fallen angels were a growing area of focus for 9fin’s analysts in recent months, as we
anticipated downgrades for a number of names whose debt is trading at stressed/distressed
levels, such as Aroundtown, the German RE firm — see Emmet Mc Nally’s excellent series
here.
Sending out a distress Signa(l)
As I said in the Workout introduction, events can happen that are big enough to have seismic
impacts. One such earthquake could be the messy collapse of Signa Holdings.
Our colleagues at Bloomberg and the Financial Times clearly thought the implosion of Rene
Benko’s real estate empire was a big deal. Most of their financial journalists chipped in,
posting numerous daily updates after a number of Signa entities were forced to file for
insolvency including Benko’s vehicle, Signa Holding on Wednesday.
Whether this is a Minsky moment for real estate is moot, but it has already created some
shockwaves, with Julius Baer issuing a statement (on 27 November 2023) reviewing its
private credit business, after detailing provisions of CHF 70m relating to a single large
exposure in its private debt loan book of CHF 606m comprising three loans to different
entities within a European conglomerate.
“The aggregate exposure towards this client group is secured by multiple collateral packages
related to commercial real estate and luxury retail and is now subject to a longer-term
restructuring.”
Signa wasn’t specifically mentioned by the Swiss Private Bank, but handily JPMorgan
analysts had published a note a fortnight ago mapping out the liabilities at Signa Prime and
Signa Development and individual bank exposures for journos to get up to speed.
As at FY22, Signa Prime Selection reported a gross asset value of €20.4bn and a balance
sheet size of €17bn. The JPM report said it had €10.7bn total financial liabilities, including
€6.7bn of total outstanding loans, €1.29bn of senior unsecured bonds and €1.34bn of hybrid
capital instruments. Signa Development had €2.3bn of total financial liabilities, including
€1.1bn of loans, €0.3bn of EHY senior bonds, and €0.4bn of hybrid capital.
Whether Signa Development will be next domino to fall is unclear, but its bonds are in single-
digits. The 2026 SUNs were as high as 70 in late September, before coming under pressure in
late October as the problems at Signa Holdings became apparent. They tanked around 17
points to 9.75-mid since Signa Prime’s subsidiary filed, according to 9fin’s data. After Signa
Holdings filed, the bonds were suspended from trading. Arini is a large holder of the notes,
as reported.
The same day as Signa Holding filed, its peer Aroundtown was holding its Q3 23 earnings
call. As Emmet McNally reported, management raised some warning signs about the
increasing difficulty of accessing bank lending amid distress in the sector, alluding to the
trouble facing the SIGNA complex without naming it directly (transcript and playback
available here).
“The lending process is taking longer and is only further protracting or slowing down. Bank
appetite for commercial property lending, especially some unnamed segments, has reduced
and they are becoming more selective (note we raised this in our recent analysis).”
The rhetoric from the Aroundtown C-suite was pretty strong, noted Emmet in his write-up:
“Management suggested there is a probability banks will become even more selective as
loans mature and borrower solvency or their ability to maintain health equity cushions is
further strained. They alluded to the SIGNA complex (more here), indirectly, and the impact of
its recent bankruptcy filings at various levels.”
Aroundtown indicated on the call that it will not be calling its hybrid perpetual notes at first
opportunity in January as their reset rates “are not much different to current bank financing”.
And there is the rub — the rising cost and lower availability of senior secured financing. In our
original analysis report in early November, Emmet called this the elephant in the room saying:
“That problem is that the cost of debt on the perpetuals tends to at least double when the
coupon resets after first call. This strains the company’s cash generation and its interest
coverage ratio. There is decent headroom on the latter, but there are close to €3.3bn of
perpetual bonds facing first call between 2024 and 2026 at Aroundtown and GCP combined,
and a doubling of the interest expense on that quantum of debt would certainly be felt in
various ways.
There is no easy solution, admittedly. Raising fresh equity when the share price is so
depressed does not serve equity interests and calling the perpetuals with cash would irk
priority bondholders. The perpetuals cannot be refinanced with other perpetuals as the cost
is too expensive and secured debt may cost close to the reset rates on the perpetuals, but
secured debt has a fixed maturity, non-negotiable interest payments and potentially
restrictive covenants, none of which the perpetuals have. Similarly, raising secured debt to
refinance the perpetuals would prime SUN bondholders.”
Aroundtown does benefit from decent liquidity, its hybrids are rated investment grade, albeit
only just (BBB- on negative outlook). S&P said in June there is a one-in-three chance of a
downgrade in the next 12-24 months under its base case. Amazingly, after two other hybrids
(totalling €1.1bn) were not called (going from zero to 50% debt treatment), they still assume
the “other hybrid bonds with first call dates later in 2023 in 2024 would be replaced at
materially higher coupons than current pricing”. I would gamble on those odds being a lot
shorter after this week’s events.
If the comments coming from panelists at a couple of restructuring lawyer events this week
were anything to go by, the situation out there is even worse than real estate companies are
reporting — I would caveat that restructuring event participants are like undertakers, always
talking up their business prospects and waiting for bodies to arrive!
One believed German commercial real estate prices have fallen by 15-20% from the peak
(officially the VDP Property Price Index showed a 10.3% YoY decline in Q3 23), but they could
still fall by another 15%. Unlike the UK, in Germany many lending banks are smaller specialist
property lenders, with a much bigger concentration of real estate debt versus balance sheet
size. Another speaker noted the ECB is concerned enough about the situation to undertake
some site inspections. Banks continue to cut lending volumes and will divert capital into
problem assets and seek to prolongate loans, unable to take write-downs in a single year.
And the fear is Signa and other potential failures will result in yet more distressed assets
coming onto the market. Many of these are development assets that will need new money
and revised funding structures to get to completion.
This should create plenty of opportunities for specialist and opportunist alternative investors.
There is a need for junior and mezzanine financing to bridge the funding gaps, and they can
name their price. For those who get it right, it could be a once in a decade opportunity.
But my gut feel is it will take another one or two quarters before the full extent of the problem
and the quantum of distress is known. We are still some way from the bottom.
As the late Charlie Munger said:
“You make your money by the waiting… It takes character to sit with all that cash and do
nothing. I didn’t get to where I am by going after mediocre opportunities.”
Dare to Care
After covering a number of care home and hospital restructurings over the years — Four
Seasons Healthcare, Southern Cross, HC One, Barchester, Care UK, Orpea — I often wonder
why they remain attractive to private equity sponsors.
Especially given the amount of negative headlines from mainstream journalists about the
evils of private equity ownership, simplistically thinking that sponsors are stripping out costs
(mostly labour) and thereby reducing the quality of care to make excessive profits.
The short answer is that the healthcare sector continues to outperform the broader market.
According to a Bain Capital healthcare report, PE deals produced IRRs of 27% versus 21% for
the industry average in 2021. Note a huge chunk was multiple expansion and I suspect a lot
of the revenue growth was via roll-ups — not a phenomenon exclusive to healthcare, mind.
Looking into care homes in particular, PE firms own three out of the largest five UK firms, but
that was just 12.6% of the total-for-profit beds according to LaingBuisson, so plenty of room
for more consolidation. In the UK and many European countries there is steady income from
governments and local authorities and supportive long-term demographics
But before I sound like a marketing document for PE fund investment in care homes, the
picture is different since the pandemic. Government support is less certain, costs have
spiralled, big staff shortages (don’t mention the B word, but look at the UK net migration stats
for clues) and labour costs are soaring due to rises in the minimum wage. In addition, there is
policy inertia over what to do with social care, but conversely the sector can help relieve
pressure on hospital beds.
Many of these issues are also prevalent outside the UK. Last year brought the collapse of
Europe’s largest care home operator, France’s Orpea, admittedly with a huge dollop of
mismanagement, negative press and potential fraud.
And Nordic Capital’s Alloheim is also struggling.
The German care home operator, as 9fin’s Laura Thompson revealed this week has fully
drawn its €100m RCF to meet interest payments and there is no sign of a refinancing plan
despite going current next February. The loans languish in the low 80s.
Another care home business trading at distressed levels is Voyage Care, a name I was
bearish on at issuance (5.875% in Feb 22), and which reported earlier this week. The February
2027 bonds are yielding a lofty 16.75% at a cash price of 73.81-mid.
After taking a look at the presentation and the transcript for the UK-based group, I think it
could be time to cover my hypothetical paper short, and maybe even go small long.
Before you send the men in the white coats over to take me away, hear me out.
Yes, Voyage Care been hurt by labour costs, with the UK minimum wage rise of 9.8%
translating to around 7% more in costs. The company hopes to recoup this with record 8-9%
fee hikes, adding that local authorities (LAs) are more open to inflation-related fee hikes. I
would caution though that most LAs set their budgets in Q1 24.
The firm’s agency staff reliance, however, is low — below 3%, and less than pre-Covid.
Admittedly leverage is rising, but management says that the 7.6x seen in Q2 23 is the peak
and that should fall to more historical levels (five and six handles) in upcoming quarters.
They didn’t give specifics, but if price rises stick and poor March and June 2023 quarters
drop out, leverage could be in the sixes by this time next year.
Cash is low (in mid-teens) but is stable, and there is an undrawn £50m RCF to call upon. Sure,
there is a springing covenant management said is based on a look-back basis and is
triggered at £26.2m of adjusted EBITDA (currently £34m on an LTM basis).
And if you believe management, the £260m of bond debt is easily covered by £320m of
property value. The LTV is a high 81%, but this drops to 60% based on the market value of the
debt.
The care homes haven’t been revalued for two years (at the time of the bond issue) and there
are no plans to do so until the next refi. Management claimed the actual value should be
higher if done now. One analyst on the call was trying to convince them to sell properties at a
higher multiple as assisted living, but that idea didn’t appear to hold much sway with
management.
And CEO Andrew Cannon is leaving after eight years (once a successor is found), creating
uncertainty at the top. He claims to have left the business in a good position, but I suspect
some of the funds that bought the bonds in February 2022 might dispute that.
Sponsor Wren House Infrastructure, which bought in during 2022, is said to be supportive. It
doesn’t have experience in the sector, although to be fair many infra-focused funds have
moved into sectors and businesses with ‘infra-like’ qualities.
Asked on the earnings call whether the company could use the RCF (not super senior) to
repurchase bonds at a discount, management said that would be up to the sponsor to decide.
Even despite recent multiple compression, I would say care home businesses could still fetch
8-9x, and there is a decent margin of safety based on the property valuation.
So, this might not be a bad entry point. I would caveat that we haven’t done a full analysis.
Dare to Care?
In (very) brief
Given that its closing on the witching hour, as I’m writing this, and well over my suggested
word count, I will keep this section even briefer than usual. There were some big 9fin content
and company updates, so I would highly recommend you click through for more info.
ATOS, the troubled French IT services behemoth finally admitted this week that its demerger
and capital increase plans were in trouble and was seeking to amend a deal with Daniel
Kretinsky. To understand more, read Denitsa Stoyanova’s two-part series — Atos to split or
twist?
Talk Talk has given a update on the sale of an equity stake in its wholesale network business.
9fin’s Nathan Mitchell estimates a sponsor equity injection of over £500m will still be needed.
Graanul has given more details on the dispute with its key customer which cost it ‘tens of
millions of EBITDA’ in 2023. The contract has been revised, but market conditions still remain
challenging. It claimed that the distress of its competitor Enviva, is unlikely to lead to price
cutting.
Adler Group has said that the German RE market in Q3 was adverse than expected, with the
direction of travel in Q4 was similar, albeit at a slower pace. It expects a further devaluation
in the low-to-mid single digits when the next revaluation occurs in Q4 2023, after booking a
8.4% negative adjustment in the first half on the value of its yielding and development assets.
What we are reading/watching this week

There was a wave of stressed/distressed company earnings this week, many of which we are
still wading through, so little time for much reading of more cerebral content. As flagged, I
spent a lot of time reading through CPI Property financials last weekend, in preparation for an
analysis of the allegations from short seller Muddy Waters. The company released its Q3
numbers late last night, and said it will fully respond to the points next week.
But it did take a swipe at the short-seller, calling it a “flashy, engaging, but erroneous report
specifically designed to discredit CPIPG’s reputation and disrupt the Group’s efforts to
support our investment-grade credit ratings”.
On its founder Radovan Vitek, it said: “CPIPG is a proud family-owned company and never
obscured our relationship with Radovan Vítek or his family. Disclosures on share buybacks,
shareholder loans and related party transactions are extensive and easy to find. On principle,
Radovan Vítek cannot ‘cream’, ‘squeeze’ or ‘brazenly loot’ his family company, as alleged by
Muddy Waters.”
It also said: “CPIPG continues to explore equity and capital raising in multiple forms. Our
shareholder, Radovan Vitek, is considering a meaningful contribution of assets and/or cash
before year-end 2023.” So even if he has brazenly looted, he may be repaying some of it.
The death of Charlie Munger has many of us going back through his quotes, I particularly like:
“Every time you hear EBITDA, just substitute it with bullshit”.
On the same subject, my favourite meme this week:
Despite a growing injury list its been a great week for Brighton (12 unavailable), with a nervy
3-2 away win at Nottingham Forest with captain Dunky sent off for calling the referee a ‘bald
pr**ck’ — a statement most football fans would concur is accurate, after a series of blunders.
And a 1-0 away win in Athens last night secured our progression to the knockout stage of the
Europa League. Not much time to recover, with nine games in December — Chelsea is next
up.

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29/04/2024, 17:48 Friday Workout — Glide paths; sending out a distress Signa(l) (9fin)

SIGNA Development 10:30 1st December 2023

9fin-Distressed Friday Workout 9fin-Feature

Friday Workout — Glide paths; sending out a

Chris Haffenden | chris@9fin

As a side-note on Private Credit, looking at Lincoln International’s EU insights Q3 report, while

Deutsche analysts are defensive on HY returns, forecasting sharp widening of spreads in a

Sending out a distress Signa(l)

As the late Charlie Munger said:

And Nordic Capital’s Alloheim is also struggling.

What we are reading/watching this week

“Every time you hear EBITDA, just substitute it with bullshit”.

On the same subject, my favourite meme this week:

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