Junk Firms Slam Into Debt Wall; AT1s Strike Back

but before we do. Julia Morpurigo with Bloomberg News, you cover distressed debt in Europe. There's always a ton of drama there. So you had a great story on a German company that has too much debt. It's not a bad business, but they couldn't afford to repay all the money that they borrowed. Now the creditors are going to take over. They essentially own that company. What's the situation

and Julia, can you walk us through it? Yes? So, Taco Fashion is a German discount retailer selling mainly clothes, and it had been owned by private equity firm Appat's partners since twenty eleven. As many other retailers. For out the years, it faced the challenge of the shift from brick and mortar stores tool online. However, the real issues came with the pandemic, which happened before Apets could exit

the company and monetize on its investment. In twenty twenty, it looked like the company was on the edge of a debt restructuring with the lockdowns shutting down stores in Germany, but eventually the performance turned around. In twenty twenty one, the cash shortfall was resolved by appats and other investors who plugged in money, and eventually in twenty twenty two, it faced an obstacle two highter surmount and at a time when the company is solding up in terms of performance.

But there's also an issue for retailers, which is the fact that high inflation is really eighty into profit margins. Last year it started talks with creditors because it faced the insurmount them all abound of debt maturing in twenty twenty three, So how much debt are we talking about? And how much was about? Some mature so the company had in total about eight hundred and thirty million euros of debt, and it was all maturing in twenty twenty three. The bulk of it was made up by five hundred

two million of vial notes due in November. But even before that there were some loans provided by banks that were coming due as soon as made twenty twenty three, an eighty million term loan and around one hundred eighty five millions of letter of credit, which are credit lines

that are needed to support a company's cash flow. But the company, obviously they got hurt by the slowdown the economy, the inflation that's obviously can the consumption side, and you know, presumingly they're also getting hit by online shopping, but they is actually making money. It's not a classic distressed situation, right, I mean, why is it really hurting now? It's really hurting now because of two reasons. First of all, there's the matter of high borrowing costs that made the refinancing

for Taco essentially impossible. The borrowing costs for junk rated companies that have really increased since the beginning of twenty twenty two as central banks across the were the raised interest rates, and that means that if they want to keep investors on board, they will have to really offer

them a really high yield on the new bonds. Taco tried actually to refine and its bonds into late twenty twenty one, but it was offering a two over yielded for investors to be interested in, and it kind of missed the momentum with the breakout of the war in Ukraine and with surging inflation across Europe. But for investors it was really hard to keep it stay invested in

their retail sector. Therefore, when individuals that have a lower disposable income, that's going to generate less demand than really going to impact top line and profits. Let me stop you there and talk about you mentioned the funding cost of shut Up. Obviously, rates globally I've gone up very very steeply, very quickly. That's caused lots of problems across the board. But when we're talking about high yields, how

much do they have to pay? I mean, you said it's too high in the market, but how much was it? Was it double digits now? Yes? So the average implied cost of new borrowing for Europe and i yeald issuers has increased from around three percent at the beginning of twenty twenty two two or around eight percent now, so it's almost three times where it was just over a

year ago. Really, and this takes into account even the best rated of the junk rated companies, and Taco being a private equity owned company, definitely did not fall in that category. So for Taco it would have been most likely in the double digits. Okay, So the last time they tried to do a transaction in the bond market, was it in double digits? Is that how much they

were offering and it didn't actually work out. I think that was just below the double digits, but it was because it was in November twenty twenty one, where interest lates were still low and central banks hadn't really started hiking them yet. But at the time, they had been on the verge of that restructuring just earlier that year, so investors didn't feel confident to piling in new bonds for that amount that they were offered, and therefore the Kann sing Gil did not go through. Later it became

impossible for them to refinance, Okay. So what I found really interesting about this story particularly is that the creditors now own the company That's not a very common situation, at least where I'm based in the US. How common is it in Europe. In Europe, it is a quite common outcome if there is a debt restructuring. You write off your debt, but in exchange for writing of your debt,

you get an equity stake in the company. Now, it hasn't really been common in the last years because we haven't had really many defaults on the companies debt, but it is something that we're seeing more and more of this year. We have seen a Spanish brideware company being taken over by creditors earlier this year called Pronavis. We have seen another Spanish casual dining chain, Telepizza, also being taken over by creditors, and we're expecting to see more

companies that follow into this path. But fixed income investors, they essentially want to own securities so they can trade out to them and you know, they can value them and also some other things. But they end up with a company. I mean, is this something that they actually want to do? I mean, they don't want to be operating a German fashion store, do they? No? I think investors that had originally bought the notes apart when they

were first issued, wouldn't want equity. Actually because they don't want equity, and because they want to don't do not want to risk the company defaulting and them getting stuck in it. They usually exit before it comes to that moment. With Taco, the bond that had been trading at the stress levels for a really long time, and so we

saw opportunistic investors. They are happier with holding the equity of a company and actually for many of them it is a strategy called loan tour new pilot to a company's debt with the view that eventually to take it over and turn it around and sell it again. And so with Taco, what we had seen and the year earlier years and months was that hedge fund silver Point Capital had built a big position in the bonds and now, alongside Albacore and Napier Park, it's the majority shareholder of

the company. So these are not common or garden mutual funds that just do sort of playing vanilla bond purchasing. These are real specialists in this area and that's what they do right absolutely, But you can also expect that although they will add a smaller position, there's going to be some power investors that will have remained stuck in

the deal. Okay, very interesting that, So just sort of looking at the bigger picture again, Companies around the world have been doing this kind of borrowing for years, taking on a lot of debt because up until quite recently it was very cheap. I mean, you know, yield and a lot of European debt were negative just a few years ago. So it's quite quite a widespread issue of over indebtedness across the board, not just in Europe, globally.

I mean to me, that means that this German situation, Taco, that's not an isolated situation by any means who's next, Julie. What are the risks of other companies going the same way? So first of all, we have to remember that a lot of company actually managed to refinance their debt in the boom years of twenty twenty and twenty twenty one when rates were still low. That means that for them the maturity wall is not near, but rather it will

come from twenty twenty five onwards. Still, we got some that didn't really seize the momentum, and adult there's a minority of them versus the broader iyel market. There are definitely some names that were keeping a track off, and especially there are some that not only they are they are facing nearing deadlines, but at the same time their performance is struggling. Among some names that work with NION,

there's a French facility management company called Italian. It has bonds due in twenty twenty four and twenty twenty five, and it's really been struggling with loves making US business and losses in its home country of France. Then you also have companies that like Taco, are actually doing okay, but they are re hurt by the fact that they have a nimin and maturity wall. One of the companies that we've been taking a close look at is a

furniture maker owned by BC Partners. It's called Ketter and it has one point two billionaires of that coming due in October twenty twenty three. Now, the issue with Catter is that they actually try to refinance in early twenty twenty two, but they were offering two low of a yield and investors pushed back on the deal. Now they have a maturity that's really getting closer, and they still haven't got a deal with investors. The company, on the

other hand, is still holding up. Okay, they have a solid liquidity buffer and it's just not enough to pay the one point two billion of that that they have coming you, So they would have to negotiate something with predators before then. So before we talk to pretty silver Bloomberg Intelligence about banks. What's the big takeaway here? Julie's um, what should we learned from this? It sounds like a

very cautionary tale. Yes, so definitely. I think that the that the lesson is to deal with your maturity was very far ahead of time, especially now that it is definitely trickier to refinance, and yeah, just proceed with caution. And the issuers also have to take into account that whatever if they can strike a refinancing deal, it will be for at a much higher price than what they were used to. Very interesting. Juliet with Bloomberg News in London.

Thanks so much for joining us. We look forward to reading all your scoops on the Bloomberg terminal and of course at Bloomberg dot com. Thank you very much. Switching gears here a bit. As I mentioned earlier, we're delighted to welcome pre to Silva. He's a senior credit analyst at Bloomberg Intelligence in Hong Kong covering Asian financial markets.

Thanks for being beyond James. So, banks have been in the news a lot lately, firstly because of the failure of a handful of regional banks in the US, then the for sale of Credit Swiss to UBS in Europe. But I wanted to ask about additional tier one or eighty one securities. So for those who were not following the recent blow up in great detail, we're talking about the riskiest form of bank debt, also known as contingent convertibles or sometimes referred to as cocos. There are sort

of hybrid security somewhere between stocks and bonds. But what is the latest on that pre great question, James, And just to give some background, as part of the eleventh our for Saler Cretty Sweets to ub S, the Swiss regulator FINMAK wiped down Credit Suiss's entire slug of additional tier one securities, which, as you mentioned, essentially preferred equity and arguably to make this forced marriage more palatable to UBS.

This write down caused an immediate, broad and steep sell off in the entire eighty one asset class, not to mention a lot of confusion. So the Bloomberg Global eighty one index, which is probably the best proxy out there for the entire asset class, dropped almost ten percent in the aftermath. But the eighty one index now is creating pretty close to pre Credit Swiss levels, having almost made

a full round trip in just two weeks. So in the case of Credit Swiss, eighty ones were marked down to zero, but equity holders actually recovered something, and so to some people that meant that the one market was essentially dead. Why does it still work and why does it work in Asia? I think in the case, I don't necessarily subscribe to that view, And the recent being is the eighty one as a class is a fairway there as a class, So anyone investing in it needs

to know that you are last absorbing capital. But as to why the equity got something and the eighty ones didn't get anything, I think it's more a practical matter. The equity for more than forty billion of booque equity got only three billion, so it's not a great recovery, but there was something in there. But I think the practical aspect of it is the regulators needed to make the deal work for the buyer, and so UBS took on created suites in the level tower, almost falling on

a grenade. And so how do you make it work by taking on less liabilities? And I think when you consider the full picture, it becomes obvious that if they were just going down the capital structure and there was seventeen billion of additional tier one securities that provided their cushion, whereas UB suffering a billion dollars or billion franc at the onset, that wasn't really going to change the dynamics

of it that much. So when this all happened and Credit switch, did, you know, shockingly to most people, essentially just disappear and you know, it's a huge financial institution. But when when the at ones were marked down to zero, this was an event that really did affect the whole of the eighty one market globally, and the ones were selling off and there was you know a bit of distress in the air. But we're basically taking away from this that what happened at Credit Swiss in Switzerland was

unique to that country. Yes, absolutely, Um, I think there were a couple factors that cost the eighty one market to rebound and rebound very sharply. One is the realization that Credit Suis was an idiosyncretic event and the other large global banks are in a much better and sound financial footing, and comments by various central bankers and public officials, including Japan's finance minister, have gone a long way in this regard. I think the second point to note is

the opportunity cost of sitting on the sidelines. When yields are at double digits, it's a lot to give up to sit on cash, and especially when an institutional investors are managing to a benchmark. And if you are to look at the Bloomberg Global co Core Index, the yield and the index right now is almost ten percent still even after the rebound. So that's a lot to give up in terms of opportunity cars. But let's talk about

the speed of the rebound. I mean, that is astonishing in that you know, only one month earlier we're talking today it's middle of April, but but in March it was a complete catastrophe that this huge financial institution, you know, solid with global reach, just blew up essentially and disappeared. I mean, but now one month later, everything's okay, yes and no. UM, it's the recovery has been almost as fast as the downturn, but it's been an uneven recovery,

so to speak. The biggest so called better credits I think, have had than others, but we still have a ways to go. And kind of going back to the same Bloomberg eighty one index. Yes, the rebound, as you noted, recovered to the index, recovered to the precs levels, but

it's still down for the year. So that's one And I think the other thing to note is we still haven't seen a major bank come to the market and spr speaking on the eleventh of March, sorry, eleventh of April, bigger pardon, MUFG, Japan's largest bank, is in the market with a four parts senior bond offering, and I think that'll go a long way towards establishing market confidence and to show that the banks can access capital markets. But I think the real litmus test is when a bank

issues a new eighty one UM. But do you expect that to happen soon? I expect Sumitomo Mitsui Financial Group, Japan's second biggest banking group, to come to the market on around April nineteenth and if that deal is successful, I think that would more or less recap our cap the rebound in the bank eighty one space. And what do you expect demand to be like for that kind

of transaction. It'll depend on pricing, I reckon. Okay, okay, just going back to the the you know, one of the fears about eighty ones was, you know, traditionally they have been called, they have been refinanced at the first

call day. Is that you know, guaranteed in age of those deals that are outside some background there in the US, coming out of the financial crisis and frank regulators made it clear to banks and to investors that, um, if you want these instruments to be treated as permanent capital, you need to treat them as permanent capital and not

call them on the first call date. And over time, studying in the UK and then in Europe, now the asset class is being treated almost like if banks will call if they if they if the economics are in the favor of the issue. And just last year April, the Australian regulator also put out a notice saying banks should only redeem additional tim and security it's on the

first call date only if it makes economic sense. So I think in most parts of the world the rules have been set so that issuers could call them or should call them only if the economics make sense. Parts of Asia it's still not treated as that, and they get called on the first call date. So disc I think could could be an interesting time. But what's interesting in Asia is in some of the maze major Asian countries there's not a whole lot of at ones come

in due. In Japan, for instance, the next Japanese N eighty one comes to you in December, so there's a lot of time. And in the case of Chinese banks, they've been redeeming and replacing offshore at ones in the on show market at lower cost. So I think between those two it's an interesting time. But let's see, because luck could happen between now and then. Yeah, I mean, the problem for me seems to be that the investors have been pricing them to call, and if they don't

get called, they panic. So there's a lot of you know, uncertainty, and investors don't like uncertainty. Yeah, absolutely, investors don't like uncertainty. But I see the point that the regulators are trying to make is if these instruments should qualify as permanent capital, then I think investors need to do a better job and be most selective about what they buy and also the structure. And if you, um, if you think something is priced not to all mail, maybe you shouldn't be

buying that. And that's my view and I think that's where credit analysts and the investment analysts should stand up and raise their hand and on their on their web page. So on the financial set to generally, I mean, you guys have never been more popular. You know, you you you you credit analysts of banks, and you know it's traditionally not been the most exciting set, and you know for good reason. But you know you've probably been up all night covering this. Um this crisis. Is it over now?

Is it over now? I think for the most part, yes, um um. The credit special event, especially around that I think is an idiosyncratic one. In the US, I think the regulators have done enough. Although I thought and I expected them to increase the US deposit insurance limit, either on a temporary basis or permanent basis, probably temporary basis, which would have really put an end to the crisis.

They had some of the regional banks are phrasing, but I think at this point we are past the peak and the bank earning season is probably the key test now. And on the regional banks, I mean, just to just to wrap this up, but regional banks that were very concentrated in a sector, you know, like Silicon Valley Bank, very concentrated in tech, and also had a ton of treasury builds on the balance sheet that were worth a

lot less than they thought they were. I mean, you know this, this small financial institution that's very very exposed to one set to Is that not an issue across the world. I mean, you don't have the same problem in Asia. In some countries. Yes, if you look at the three banks that failed in the US, they were all very highly concentrated in one way or another, either tech or crypto or something around the lines. In Asia, we do have banks like that, and occasionally they tend

to get more into trouble. And what I do like about the larger banks is their diversity. And if you are a large, well diversified bank, if one or two off your lines of business aren't doing that well, you still have others, other businesses that are pulling the weight. And the same goals with the risk profile at the company. So yes, there are a smaller banks that are, but I call mono line institutions and they are more rescued

them the more diversive faid months. But the good thing from a credit investor standpoint is more so the debt outstanding tends to be issued by the larger, more diversified banks. So I think that's the saving grace for credit investors. Very good, Thank you very much, Pretty Silver Bloomberg Intelligence. You can see all of his analysis on the Bloomberg terminal. There's a lot going on in banking, so do check it out and pleasure to see you pretty. Thanks a lot.

We'll have you back on the show soon. Likewise, see you then, take care. Thanks a lot, and thanks again to Julia more Portugal from Bloomberg News. We'd all her scoops on the terminal and at Bloomberg dot Com. I'm James Crumby. It's been a pleasure having you. See you next week on the Credit Edge.