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News in brief

February 2022 | Issue 242
Not so distressed any more for table-topping hedge funds
Following a raft of global fiscal support programmes over the past couple of years, it would seem likely that distressed debt funds have struggled to find opportunities.
Yet overall, they were the best performers in 2021, as the Creditflux hedge fund index for distressed funds hit 16.72% for the year.
This gain was powered by Serone European Special Situations (which rose 24.47%), Pictet Alt — Distressed & Special Situations (up 22.17%) and Angelo Gordon’s Corporate Credit Opportunistic Fund (up 17.05%).
CLO funds gained 14.78% in 2021.
Ironshield prepares for ‘choppier’ kind of dislocation
Distressed debt investors are casting an eye over Europe as a cocktail of inflationary pressures, supply chain shortages and geopolitical risks weigh on corporate credit. Add to that a sharp rise in energy prices and there appears to be no shortage of catalysts for a sell-off.
David Nazar, founder and managing partner of credit hedge fund Ironshield Capital Management, thinks these conditions could lead to the fifth big opportunity for distressed debt investors in recent years.
“Over €120 billion of European high yield bonds were issued last year, and essentially the whole of the outstanding European high yield market has been issued at a time of multi-century low rates,” Nazar says.
“If there’s an adjustment in rates upwards, that will test the market. Any low margin business will face a lot of challenges balancing cost and revenue inflation.
“Companies that have 2-3% margin, with inflation running at 1.25 points per quarter — even if cost increases cannot be passed through for one quarter — will be in a difficult situation. Some companies may do well out of an inflation environment, but some won’t.”
While the telecoms bust, Lehman Brothers’ downfall, the Eurozone crisis and coronavirus pandemic have all resulted in sharp falls, where investors made money in the recovery play, Nazar says the next crisis could be more of a slow burn.
He says the biggest challenge for distressed investors will be navigating these opportunities in markets that will likely be choppier and not as forgiving as those dislocations. Previously, central banks cushioned the markets, but they are now constrained by inflation.
Booster mandates leave unvaccinated further in the cold
US credit asset managers are starting to make coronavirus vaccination boosters part of their recruitment policy requirements, sources say.
Citi, the most high-profile firm to make clear it would fire staff who are not fully vaccinated, only requires employees to be double-jabbed against the virus.
One recruiter in New York says his clients are refusing to speak with anyone who is not vaccinated, but he believes asset managers will relax their stance over the course of this year.
“Unvaccinated candidates are not getting interviews, but as the population gets herd immunity, or if a vast majority of citizens are vaccinated, then I think the vaccine mandate will fade,” he says.
In New York, rules dictate that anyone working in an office must be fully vaccinated.
Citi, which permits vaccine exemptions on religious or medical grounds, has said that more than 99% of its workforce has met its criteria.
Performance dispersion hits index equity correlation
Volatility at the start of the year has intensified moves in iTraxx and CDX index tranches, with traders pointing to growing dispersion in performance among constituents as a theme that will bring more focus on equity correlation in 2022.
Equity tranches widened in January as high yield and investment grade indices came under selling pressure due to concerns about inflation, energy and the omicron covid-19 variant. So far there has been a slight underperformance of iTraxx Crossover versus CDX HY equity, despite a bigger deterioration in the US index.
The 0-15% equity tranche of CDX HY series 37 has widened from 45.1 points to 49.9, approaching levels it last hit at the start of December, with base correlation falling this month from 0.35 to 0.33. Series 35 equity has widened 4.5 points to 41.
Investors note that some of the riskiest constituents of the index — such as American Airlines, Carnival Corp, Diamond Sports, Nabors and Transocean — have frequently been among the biggest movers of each trading session. The latter company started the year around 46.75 points up front in five-year CDS, rallied to 40.75 PUF by 12 January and has since reverted to 44.25 PUF.
The 0-10% equity tranche of iTraxx Crossover series 36 has widened from 48.3 points to 53.3, even though base correlation rose a touch over the month from 0.39 to 0.4, having been 0.43 back in October.
Crossover wide-end constituents have generally been less volatile than those in US high yield counterpart index CDX HY.
Direct lenders look to support venture-backed businesses
European direct lenders are exploring deal transactions based on annual recurring revenue (ARR) financings, according to market sources.
Tikehau’s head of private debt, Cécile Mayer-Lévi, told Creditflux in January the firm had been increasingly involved in complex, technical transactions just out of the venture first round series financing, where companies are starting to consider they could rely on debt financing to limit dilution.
“We are seeing companies where the management team or shareholders rely on private debt solutions to limit dilution, especially for roll-out strategies,” she says. “These transactions, however, have different covenant metrics. The deals are focused on gross debt rather than relying on cash-flow generation, and the companies aren’t necessarily profitable already, but there is more upside potential.”
Since these companies lack meaningful ebitda, performance is measured by annual revenue produced on a recurring basis (for example, subscription sales). ARR deals are prominent in the tech sector, where nascent firms can incur significant start-up costs, but can quickly scale up and become profitable.
In a published note from Hogan Lovells, partners Francis Booth and Jo Robinson say documentation is largely similar to traditional deals, but with an ebitda leverage test swapped out for a leverage test based on ARR, at least for the first two or three years. There is scope to flip back to an ebitda leverage test.
“Given the increased scrutiny on cash reserves in the early stages of the business’s life-cycle, the lender will also have the benefit of a liquidity covenant,” they say.
Bond pipeline builds as rocky markets thwart supply
Various factors have played into credit spreads widening at the start of 2022, but an over-supply of bond issuance is not one of them — in contrast to what was moving the market this time last year.
Expectations had been high going into 2022 that this would be a strong year for bond issuance, especially given borrowers’ preference to lock in fixed-rate debt ahead of a regime of central bank rate hikes.
But while early signs in January suggested a bumper start for investment grade, high yield bond issuers have barely got off the starting line.
High yield has been an all-round disappointment, with rocky trading sessions resulting in lower issuance than investors had anticipated. Only $12.1 billion of US dollar bonds had been issued at time of press, according to Debtwire Par, compared to a whopping $49.6 billion in January 2021.
One factor has been that recent deals have performed poorly on the break, discouraging other would-be issuers. Value has eroded from high yield bond indices, with the US underperforming Europe.
But this means there has been a build up in the pipeline that could spell a much better February, should less volatile windows allow.
At time of press there were about $6 billion of US high yield bonds set to come to market within a week, while Europe waited on at least nine issuers, including Morrisons, which was expected to launch a £5.6 billion ($7.6 billion) bond and loan financing for its take-private by Clayton, Dubilier & Rice.
Credit unprepared as Russia and Ukraine spreads go on march
Huge moves in Russian and Ukrainian credit spreads have exposed the growing mismatch between assessments of a likely conflict between the two countries, and the neglect of investors to price in its impact on broader markets.
Concerns mounted in January that the US and Russia would fail to find a diplomatic way forward over Ukraine, after 100,000 Russian troops lined up on its eastern border. But very little core credit market discussion or investor positioning has reflected this.
“The market has had its head in the sand,” says Tim Ash, economist at BlueBay Asset Management. “There are various factors why Putin might see it as now or never. He’s frightened by Ukrainian democracy and the carbon transition means Russia’s energy leverage will diminish. The Russian macroeconomic picture is better than at any time over the past 30 years to ride through the instability caused by a major war. And Putin has been preparing for this moment since the annexation of Crimea.”
Ash warns that Russian assets are likely to sell off because sanctions would have a significant impact on the country’s economy. European energy prices will also be a major concern. Ukraine five-year CDS has been widening since mid-September, when it was 378bp. It is at 1,483bp as Creditflux goes to press.
Most bank research has downplayed the likelihood of a military invasion. Some commentators, including Eurasia Group president Ian Bremmer, have claimed the risk of Russian intervention in eastern Europe has bolstered Nato, which leads them to suspect Putin will avoid a full military incursion into Ukraine.
Whitestar swoops for US CLOs as it readies European deals
MacKay Shields has completed its exit from CLO management after it emerged that the asset manager has transferred the rights to two of its US CLOs to Whitestar Asset Management.
In December, Whitestar announced it was taking on MacKay Shields’ European CLOs as it sought to establish a continental CLO business, but it did not reference MacKay Shields’ US CLO business.
The US CLOs — MKS CLO 2017-1 and MKS CLO 2017-2 — were launched by Credit Value Partners and were thrust upon MacKay Shields after parent company New York Life decided to absorb CVP into MacKay Shields in 2019. These CLOs have now been taken on by Whitestar.
The Dallas-based manager had $7.6 billion of US CLO assets under management at the end of last year, according to Creditflux data.
By taking on four MacKay Shields CLOs (two US and two European) it will add $1.42 billion to its AUM.
As Creditflux goes to press, sources say Whitestar also has two new European CLOs in the pipeline after signing mandates with Jefferies and JP Morgan.
Two CVP CLOs (Cascade 1 and 2) did not move to MacKay Shields in 2019. Instead, Barings, which was named as replacement manager in the CLOs’ documentation, took over as collateral manager.
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Global credit funds & CLO's
February 2022 | Issue 242
Published in London & New York.
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