Azhar’s crunching credit – July steady as high issuance continues

July was a steady month with marginal spread widening but a significant move in government bonds pulling yields tighter and providing healthy returns across fixed income markets.

Key indicators

• The US 10-year treasury yield tightened by 37 basis points (bps) during the month to end at 4.03%.
• Investment grade bonds outperformed high yield bonds. Global investment grade returned 2.12% (+2.40% year-to-date) and global high yield returned +1.74% (+5.20% YTD).
• High yield spreads were 6bps wider at 364bps, CCCs were 28bps wider, whilst single Bs were unchanged and BBs were 8bps wider.
• Investment grade spreads – tightened by 2bps to 103bps.
• The default rate fell by 0.3% to 2.2%, this breaks down as US 1.8% (-0.1%), EU 1.9% (-0.2%) and emerging market 5.5% (-1.1%). The gap between smaller issuers and larger issuers fell to 0.7% from 0.9% as the small cap default rate was down 0.2% at 2.0% whilst large cap default rates were unchanged at 1.3%.

Issuance continued apace with $38bn in global high yield bonds, $115bn in investment grade bonds and $35bn in leveraged loans. This takes high yield volume to $295bn YTD, (versus $285bn last year). Investment grade is currently tracking at $957bn (vs $1.1trillion last year) and loans at $323bn (vs $233bn last year).

Credit stories – temporal seniority

Two words that are often not cited sufficiently but that we pay close attention to are ‘temporal seniority’: the seniority that one class of debt has over another by virtue of when it is due to mature. Rating agencies like to ignore this and in our view this creates real opportunities for debt investors who can identify these opportunities.

The abundance of capital, combined with over leveraged capital structures, is focusing the minds of many debt investors and back in March we wrote about three situations (Intrum, Ardagh and Altice France) where identifying the sticks and carrots would be key to calculating what would happen. The stick for a short-dated bondholder was likely to have to be much more severe as the carrot of redemption was something which was likely to happen pretty quickly unless the company could act aggressively.

Two of these situations have already been partially resolved. First we had Ardagh Glass who redeemed their 2025 bonds at 100 and created a new instrument to try to subordinate later maturities. Second, following hot on their heels this month we have Intrum, who this month met the redemption of their 2024 bonds whilst offering a debt swap for longer maturity bondholders.

In both of these cases the first maturing bonds had a ‘temporal seniority’ that could only be impaired by a default and the equity owners weren’t willing to try this much harder solution as it would give up their control and optionality. Our view (based on a long experience in investing in these situations) is that the toolkit investors should use to gauge temporal seniority is determined by three factors: the quantity of the debt due to mature; the motivations of the equity owners; and the current state of the company’s cashflow.

In the case of Ardagh Glass, the 2025 maturity was due in less than a year (March 2025 versus the next maturity being a late 2026) and was less than 17% of senior debt. In Intrum’s case, the 2024 maturity was just four months from when the company first announced it was looking at restructuring options, and was just 13% of total debt.

This leads us to the third situation which is that of Altice France. This remains outstanding, but we again think that the likely outcome is that the first maturities (due in just six months) are likely respected given the small quantum of debt (3% of total senior debt) and the lack of a serious stick that could emerge in this short time period (the next maturity after the 2025s is 2027).

Another name we have commented on previously is AMC Cinemas and in July we had news that it was using the robust markets to extend its debt maturities. AMC is an unusual case in many ways – not least its novel use of meme stock notoriety to continually issue stock at inflated prices to repay its debt load – but its $3.3bn of 2026 maturities (out of a total debt pile of $9bn) similarly had temporal seniority over the rest of the capital structure and the company thus had to extend the maturities by giving up valuable collateral at the cost of the other debt maturities. With $1.6bn extended and $800m targeted to be bought back, AMC diminished the near-term likelihood of default and also created a new exchangeable (a convertible!) to take advantage of its meme stock status.

It looks like we should have followed the Reddit boards for credit tips after all!

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