Azhar’s crunching credit – April sees negative returns after strong start to year

After five months of good news, April proved to be a tougher month as spreads tightened but government bond yields rose significantly leading to negative returns.

Key indicators

• The US 10-year treasury yield widened by 47 basis points (bps) during the month to end at 4.67%.
• High yield bonds outperformed investment grade bonds. Global investment grade returned -1.8% (so -1.7% year-to-date) and global high yield -0.8% (so +1% ytd).
• High yield spreads were 3bps tighter at 355bps, CCC’s were 43bps wider (31bps due to rebalancing), whilst single B’s were 13bps tighter and BB’s were 7bps tighter.
• Investment grade spreads – tightened by 3bps to 100bps.
• The default rate increased by 0.2% to 2.9%, this breaks down as US 2.3% (+0.1%), EU 2.0% (+0.6%) and Emerging market 7.6% (+0.1%). The gap between smaller issuers and larger issuers fell to 2.1% from 3.4% as the small cap default rate was down 1% at 3.3% whilst large cap default rates were up 0.3% to 1.2%.

Credit stories

A theme from last month has been the rise of defaults due to ‘LMEs’ (Liability Management Exercises), currently 63% of defaults are due to LME’s. This is a function of the plentiful liquidity and loose covenants of the last decade combining to provide a potent cocktail which is enabling equity holders to extract more than their economic values.

Ardagh Glass was a name we mentioned last month and post month-end it raised liquidity to repay its first maturity of debt due in 2025. They raised senior liquidity with a better collateral package via a private debt transaction with Apollo. A few lessons here as it shows the power of being at the front of the queue when debt is due but also what matters is the quantum of debt due, Ardagh redeemed its $700m 2025 bonds in full whilst subordinating its $2.5bn of 2026 bonds – so temporal seniority is even more important in situations such as these where equity holders are trying to extract economic value. What was interesting about this transaction was that the new facility also empowers Apollo to buy subordinated tranches of debt and swap these for senior collateral. Some commentators have entitled this ‘Hunter-Gathering’ and it certainly is a fascinating development as the company can use this arm’s length transaction as something to give it reputational cover – something arguably necessary in entities which are debt reliant.

We also had a deluge of conventional new issuance across the month – the $39.4bn taking the year to $165.5bn (this compares to $92.2bn over the comparable period last year). 

With yields having retracted over the last six months we had a few European high yield stalwarts come to refinance their maturities:

Alarm company Verisure came to the market to issue a €500m bond and a term loan to redeem an existing term loan and other bank debt. Their existing 2028 term loan had paid a margin of 325bps, and with current Euribor rates, this meant a current coupon of 7.0%. The new TL has a margin of 350bps but with the associated bond pricing at 5.5%, this meant the company’s cost of capital fell by around 1%.

Metering company Techem issued €500m 2029s as part of a €2.3bn bond and term loan refinancing. Techem was redeeming €1.1bn of 2% 2025 notes and €1.1bn Euribor +237.5bps term loans so its blended cost of capital increased by over 1% as it paid a 375bps margin on its new term loans and 5.375% on its new bonds. The private equity owners are currently considering a sale/IPO of the business, so they retained financial flexibility to reduce its debt load by virtue of issuing loans and (non-conventional) equity claw back language to allow them to redeem bonds at 102 in the event of an IPO. 

April was a month where normality reigns supreme, companies have adjusted to a higher cost of capital and interestingly the idiosyncratic stressed situations are countered by an extremely permissive credit climate where covenants are loosening further as the weight of demand is suppressing not only spreads but also protective features.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.