barcap on distressed debt markets
TRANSCRIPT
CREDIT RESEARCH 1 October 2010
PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 22
EUROPEAN CREDIT ALPHA More answers than questions
Matthew Leeming
+44 (0) 20 7773 9320
Zoso Davies
+44 (0) 20 7773 5815
Arup Ghosh
+44 (0) 20 7773 6275
Eugene Regis
+44 (0) 20 7773 9169
Aziz Sunderji
+44 (0) 20 7773 7881
Dominik Winnicki
+44 (0) 20 3134 9716
www.barcap.com
This version corrects Figure 3, where the scale was incorrect on the left hand axis.
Strategic Market View: There and back again 4
Driven by mixed signals from the economic and political front credit spreads see-sawed this week before finally ending up where they started. Risk aversion remains, but largely driven by macroeconomic uncertainties, while strong corporate fundamentals should provide spreads with a buffer if future growth stays anaemic. Sovereign volatility continues to drive valuation dislocations and we highlight a credit-equity normalisation trade on EDP. For investors worried about poor economic growth, we also recommend going long a basket of selected names with counter-cyclical performance while simultaneously shorting the index as a suitable trade for generating counter-cyclical alpha.
Distressed debt markets – time to grow 9
We see the European distressed debt market as growing in size. This will come from weak borrowers who survived on forbearance measures and the low rate of Euribor hitting maturity and amortisation points and European banks continuing with balance sheet shrinkage. Also, with the cost of bailing out Europe’s banking systems via bad banks increasingly interlinked to sovereign funding rates, there is further potential for distressed assets to come from both bad banks and distressed banks.
Credit at a glance 16
Corporates generated just over 50bp of excess returns in September, led by financials and in particular the Tier 1 part of the capital structure. Insurance, which is more heavily weighted towards Tier 1 than banking, was the top performing sector this month – utilities underperformed. Indices were marginally tighter week on week, while investment grade cash was wider. Despite this, our measure of the cash-CDS basis was broadly unchanged as single-name contracts lagged the index tightening.
Barclays Capital | European Credit Alpha
1 October 2010 2
CREDIT VIEWS ON A PAGE CREDIT STRATEGY
CATEGORY THESIS TRADE IDEAS High Grade Monetise steep skew, hedge
against moderate widening 1x2 payer spreads on Main to December
Use bank Tier 1s to boost yield or beta
Despite the rally that has reduced the pick-up to senior, we continue to believe there is value in European bank Tier 1 as a high-beta asset class
Relative value in step-up bonds
Switch into Lafarge step-ups: LGFP €7.625% 2014 and LGFP €7.625% 2016s
Relative value trades between corporates and sovereigns
Short corporates trading tighter than their own sovereign (only in AAA sovereigns)
Cyclical hedge in CDS Basket of cyclical shorts vs index: LMETEL (Ericsson), MICH, PUBFP, STM, VLOF, WKLNA, WPP Basket of cyclical longs vs index: BNFP (Danone), ROSW, EXHO, TSCOLN, ULVRLN
Normalisation trades Yield/credit curves steep at front end, buy short-dated credit Basis trades > -100bp
High Yield Relative value across ratings buckets
We favour single-B-rated paper and expect it to compress towards BB
Relative value in senior vs subordinated cash
On capital structures of performing names with secured and unsecured bonds, unsecured tiers look attractive: Buy Ardagh € ‘17, Ineos € ‘16, Europcar € ‘14 and Lecta € ‘14 against secured issues
On capital structures of performing names with term loans and pari passu secured bonds, buy the secured bond: Buy Smurfit € ‘17/19 against term loans
Trades on issuers we expect to refinance
Loans or short-duration bonds trading sub-par, which we expect to be refinanced Short-duration paper on high-beta credits with strong liquidity Selected name-specific 5s10s DV01 neutral steepeners for borrowers we expect to refinance
Returns are hard to find We favour bonds with cash yield above the current yield of the index
Event-driven trades: LBOs
Cash Switch into bonds that are closer to maturity to reduce sensitivity to spread widening and curve steepening Switch into bonds with protective covenants, such as change-of-control (CoC) puts and/or
step-up coupons
CDS Buy outright CDS protection on an LBO target; Buy outright CDS protection on a target and sell protection on a correlated index
Implement a CDS steepener on a potential candidate
Equity options Long equity call options for LBO candidates
HIGH GRADE CREDIT RESEARCH
SECTORS OVERWEIGHT UNDERWEIGHT Banks, Consumer, Industrials Telecoms, Media, Technology, Utilities, Pharmaceuticals
COMPANIES FAVOURED*: OVERWEIGHT – BONDS/SELL PROTECTION – CDS
UNFAVOURED*: UNDERWEIGHT – BONDS/BUY PROTECTION – CDS
Autos BMW (CDS), Daimler (CDS) BMW (cash), VW (cash), Volvo (cash), Michelin (cash) Banks RBS (cash), Commerzbank (cash), UniCredit (cash) Allied Irish Banks (cash), BCP (cash), BES (cash), Dexia (cash),
Monte dei Paschi (cash) Consumer & Retail Accor (cash), Kingfisher (cash), Rentokil (cash), Metro, BAT,
Imperial Tobacco, Tesco (CDS), PPR (CDS) Carrefour, Next (CDS), Diageo, Experian (CDS), Carlsberg (CDS)
General Industrial BAA (cash), Finmeccanica, Alstom (CDS), CRH, Clariant (cash), Thyssenkrupp (CDS)
Metso, Akzo Nobel, Bayer, Clariant (CDS), Rolls Royce (CDS), Lafarge, Sanofi-Aventis, Holcim (cash)
Insurance Stalif (cash), Llydin (T1), Eureko (bonds), Munich Re (bonds), Zurich (bonds)
Aegon (CDS), Hannover Re (CDS), Generali (CDS), Unipol (CDS)
Pharmaceuticals Roche, Novartis (cash) AstraZeneca TMT BT Group, OTE, Telefonica, Lagardère, Swisscom (CDS),
Telenor (CDS), Nokia (CDS) Deutsche Telekom, Vodafone, TeliaSonera, TKA, KPN, STM (CDS), FT, Ericsson, Pearson** (CDS), Portugal Telecom (CDS), Wolters Kluwer (CDS), Ericsson (CDS), WPP (CDS)
Utilities EDP, Enel, Gas Natural, Veolia Environnement, REN, Glencore, Iberdrola (CDS)
United Utilities Plc, Suez Environnement, Elia, Verbund, Edison, Fortum (CDS), EnBW (CDS), Vattenfall (CDS)
HIGH YIELD CREDIT RESEARCH
COMPANIES FAVOURED*: OVERWEIGHT – BONDS/SELL PROTECTION – CDS
UNFAVOURED*: UNDERWEIGHT – BONDS/BUY PROTECTION – CDS
Basic Industries Ardagh Glass 2016/2017/2020, Lecta 2014 (sub + snr), M-Real 2013, Smurfit Kappa Group 2015/2017/2019
Clondalkin Industries 2013/2014, Norske Skog 17s
General Industrial Evonik Degussa 13s, Evonik Industries 14s, Savcio, HeidelbergCement 2012/2014/2017/2018/2019, Valeo (cash), GKN (CDS)
Lufthansa (cash), Air France (cash), Stora Enso, UPM
Consumer & Retail Pernod (EUR) TMT Wind €11.0% 2015, KDG €+700 PIK 2014, Seat €8.0% 2014,
Unity €8.125% 2017, UPC €8.0% 2016 Ono €8.0% 2014, €10.5% 2014, Unity €9.625% 2019, Virgin Media £7.0% 2014
Note: Recent changes where available are in bold text; *ratings below apply to bonds and CDS (where applicable) unless specified; **Barclays Capital is acting as financial advisor to Pearson PLC in its potential acquisition of Sistema Educacional Brasileiro's school learning systems business. Source: Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 3
REPORTING CALENDAR
Next Week
Date Company Release/event Economic data
Mon, 4 Oct US: Pending home sales, Factory orders EZ: Sentix, PPI UK: Construction PMI
Tue, 5 Oct Tesco Tui Travel
H1 interim results Interim sales
US: ISM non-Manufacturing EZ: Retail sales, PMI UK: Services PMI
Wed, 6 Oct Sainsbury Q2 sales US: ADP employment report EZ: Q2 GDP (Final) GE: Factory orders
Thu, 7 Oct M&S Q2 sales US: Consumer credit, Jobless claims EZ: ECB Rates decision GE: IP UK: NIESR GDP Estimate, BoE rates decision, IP
Fri, 8 Oct US: Non-farm payrolls, Unemployment, Wholesale inventories GE: Trade balance UK: PPI
Source: Bloomberg, company reports, Barclays Capital
The week after
Date Company Release/event Economic data
Mon, 11 Oct Securitas Sodexo Ladbrokes
9M results FY results Interim trading update
Tue, 12 Oct US: FOMC Minutes, Small business optimism GE: CPI UK: Trade balance, RPI, CPI
Wed, 13 Oct Casino Q3 sales (after mkt) US: MBA Mortgage applications, Budget EZ: IP UK: Unemployment report
Thu, 14 Oct Carrefour Diageo Roche SABMiller Suedzucker Syngenta
Q3 sales Interim statement Q3 sales Q2 sales Q2 results Q3 sales
US: PPI, Jobless claims, Trade balance, EZ: ECB Monthly report
Fri, 15 Oct US: CPI, Advanced retail sales, Retail sales, Empire manufacturing, U. of Mich. Confidence, Business inventories EZ: CPI, Trade balance, Car registrations
Source: Bloomberg, company reports, Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 4
STRATEGIC MARKET OVERVIEW
There and back again Driven by mixed signals from the economic and political front credit spreads see-sawed this week before finally ending up where they started. While risk aversion remains strong we believe it is driven more by macroeconomic uncertainties, as corporate fundamentals are the strongest they have been for a long time. This is not reflected in current valuations, a fact that should provide spreads with a buffer if future growth remains anaemic. Sovereign volatility continues to drive dislocations for corporate names, and we highlight an attractive credit-equity normalisation trade on EDP, where the CDS has been widening in tandem with its sovereign even though the stock has barely moved. We also revisit our trade idea from last week to generate counter-cyclical alpha. We recommend going long a basket of selected names with counter-cyclical performance while simultaneously shorting the index as a suitable trade idea for investors worried about poor economic growth.
Arup Ghosh +44 (0) 20 7773 6275
Matthew Leeming +44 (0) 20 7773 9320
Aziz Sunderji +44 (0) 20 7773 7881
Dominik Winnicki +44 (0) 20 3134 9716
Zoso Davies +44 (0) 20 7773 5815
Week in review
Credit continued to trade rangebound this week. Having widened by 7bp on Tuesday, the iTraxx main index ended the week back where it started it at 110bp. A mixture of news, both good and bad from either side of the Atlantic has led to a lack of conviction and light trading volumes. The upshot has been cash outperformance relative to CDS, with the basis turning more positive for investment grade names.
There has been a sharp divergence in credit views across Europe in the past few days. The general macroeconomic picture seems to be improving; the 3m LTRO on Wednesday and the subsequent fine tuning operation saw much lower demand than the market had expected signalling an improved liquidity position for European banks. Stronger peripheral sovereigns like Spain and Italy also saw good demand for their bonds in auctions. At the same time concerns remain around the banking sector in Ireland and fiscal conditions in Portugal, which have led to their sovereign CDS spreads widening over the past month as other peripheral spreads tightened (Figure 2).
Figure 1: Peripheral European sovereigns have seen diverging performances over the last month…
Figure 2: … while the sharpest changes recently have been in the Irish sovereign CDS curve
400
420
440
460
480
500
520
0 2 4 6 8 1
540
560
0
30-Sep-10 23-Sep-10
guarded optimisim
The Irish finance minstry's plan for further capital injection in Anglo Irish bank was greeted by the market with
400
420
440
460
480
500
520
0 2 4 6 8 1
540
560
0
30-Sep-10 23-Sep-10
guarded optimisim
-200
-150
-100
-50
0
50
100
150
Portugal Ireland SovX Spain Italy Greece
Net 1 month spread change (bps)
While the aggregate sovereign index has stayed virtually unchanged, European peripherals have seen a sharp divergence in performance
The Irish finance minstry's plan for further capital injection in Anglo Irish bank was greeted by the market with
Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 5
On Thursday the Irish Central Bank unveiled a fresh recapitalisation plan for the banking system, with additional costs expected of around €10bn in a base-case scenario and €15bn in a “stress scenario”. Of this €4.3bn is for Anglo Irish bank, bringing net capital requirements for the bank to €29.3bn from previous estimates of €25bn. These costs are expected to bring Ireland’s fiscal deficit to 32% of GDP, much higher than the 3% guideline for Eurozone countries. The Irish finance minster conceded in an interview that the large size of Anglo Irish as a proportion of the country’s balance sheet means it is “systemically important” and its failure cannot be contemplated. The plan reaffirms the government’s intention to make senior bondholders whole on their investment, but seeks to impose write-downs on subordinated bond holders as had been expected. The market reaction to the announcement has been moderately positive, and Irish sovereign CDS curves have started steepening in the front end. This seems to suggest that with this fresh capital injection Ireland might be able to finally draw a line under the banking crisis that has been threatening to plunge the country into a double-dip recession.
Adding to the mixed economic signals in Europe is the continuing slow burn of political uncertainty across both core and peripheral countries. Wednesday saw trade unions co-ordinate protests across a dozen European countries. These included a day-long general strike in Spain protesting against labour reforms and austerity measures undertaken by the current government, as well as a demonstration in Brussels. Also on Wednesday the European Commission proposed plans to impose fines on fiscally undisciplined member states, though consensus on such regulations might be hard to achieve. France announced its 2011 budget stating it intends to cut its public deficit by 1.7% of GDP, while Italy announced it should be on track with its three-year deficit reduction programme.
Last week’s volatility and heightened uncertainty led to a couple of casualties on the corporate issuance front. Telefonica and RCI Banque pulled proposed deals after citing difficulties in pricing and reduced interest given the challenging market conditions. Overall primary markets priced c.EUR7bn of debt this week, bringing the total EUR-denominated issuance to c.EUR45bn in September, significantly behind the USD92bn of dollar-denominated unsecured debt priced in September. The GBP6.25bn of investment grade debt priced in September makes it the busiest month of 2010 for sterling markets.
Whither corporate spreads? Corporate spreads in Europe are currently being driven to some extent by the market’s risk aversion due to prevailing macroeconomic uncertainty. While we expect this to continue over the short to medium term, over a longer horizon we expect spreads to start reflecting the underlying fundamentals of these corporate names.
In Figure 3 we plot the time series of average net debt to EBITDA for European investment grade corporates going back to Q1 02. We based our universe on a subset of the names included in the Barclays Capital European Aggregate Industrials Index, and take into account the changing cohort over time.
Barclays Capital | European Credit Alpha
1 October 2010 6
Figure 3: While average leverage seems to be at one of its lowest levels since 2002, cash spreads do not seem to be reflecting this entirely yet
1
2
3
'02
Q1
'02
Q3
'03
Q1
'03
Q3
'04
Q1
'04
Q3
'05
Q1
'05
Q3
'06
Q1
'06
Q3
'07
Q1
'07
Q3
'08
Q1
'08
Q3
'09
Q1
'09
Q3
'10
Q1
'10
Q3
0
100
200
300
400
ND/EBITDA (LH axis) L-OAS (RH axis)
Note: The leverage and spread values here are averages for the Barclays Capital European Aggregate Industrials Index. Source: Bloomberg, Barclays Capital
As is evident, European corporates have sharply delevered since the beginning of the credit crisis, to the extent that average leverage now is at one of the lowest levels since 2002. Spreads haven’t quite moved in line with this, however, and we believe that as macro uncertainties fade and risk aversion retreats, spreads should move tighter to reflect these improved fundamental levels. In fact, the very strong fundamentals should also buffer spreads from widening too much in the event growth remains anaemic for a while albeit presuming macro uncertainties do not intensify over the same period.
Has ELEPOR gone too far? The concerns around Portugal’s fiscal conditions while driving up its sovereign spreads are also affecting ongoing deterioration in Portugal including names such as ELEPOR, PORTEL and BESPL. Driven by sovereign contagion these credits have been widening since early September, but this contrasts with the relative resilience in stock prices of these companies.
CDS underperformance versus equity has been particularly strong in ELEPOR. While the CDS has been tracking Portugal sovereign CDS very closely on the way up in September, the stock has been trading quite firm and is now slightly above its September average (Figure 4). Judging by the two-month historical relationship between the CDS and the stock, the equity-implied CDS spread is now c.50bp tighter than the current market level.
Barclays Capital | European Credit Alpha
1 October 2010 7
Figure 4: Sovereign weakness drives EDP wide but the stock price barely budged
Figure 5: P&L of the trade for data points over the recent past
130
180
230
280
330
380
2.35 2.4 2.45 2.5 2.55 2.6 2.65
Stock price (€)
CDS spread (bp)
July-August September Current
LOSS
PROFIT Breakeven
Source: Barclays Capital Source: Bloomberg, Barclays Capital
2.2
2.3
2.4
2.5
2.6
2.7
01Jul
15Jul
29Jul
12Aug
26Aug
09Sep
23Sep
Stock price (€)
150
200
250
300
350
CDS spread (bp)
130
180
230
280
330
380
2.35 2.4 2.45 2.5 2.55 2.6 2.65
Stock price (€)
CDS spread (bp)
Given the unusual strength of credit-equity dislocation and the fact that we hold a positive fundamental view on the credit, we recommend the following normalisation trade idea:
Trade idea: Sell €2mn protection on ELEPOR 5y CDS
Sell short €0.6mn worth of ELEPOR stock
Note: At the time of writing EDP 5y CDS was trading at 305bp bid and EDP stock price was at €2.504. Cost of borrowing EDP stock is c.35bp.
If the sentiment around Portugal improves, in our view, CDS would have more room for positive adjustment compared to the already strong stock. On the other hand, if the weakness in Portugal sovereign CDS continues and ELEPOR keeps trading wide, the stock should eventually catch up, as the increased cost of funding and deteriorating sentiment start to weigh on valuation. The choice of the notional sizes of the trade legs was based on last three months’ relationship between the CDS spread and the stock price.
Hedging smarter redux We have previously suggested that investors concerned about poor economic growth could generate counter-cyclical alpha by shorting selected names within strongly pro-cyclical sectors (see European Credit Alpha, 24 September 2010). An alternative approach, which we discuss here, is to be long counter-cyclical sectors versus the index.
A number of sectors have a strong correlation to GDP growth over the economic cycle, but a negative beta (Figure 6). Indeed, their counter-cyclical performance is clear over several cycles (Figure 7 and Figure 8). In particular, we highlight Healthcare, Retail and Food & Beverages – the counter-cyclicality of Retail being driven by non-cyclical distributors such as Tesco, Sainsbury’s and Carrefour. One advantage to being long defensive sectors versus the index is that investors are implicitly short both financials and peripherals.
July-August September Current
LOSS
PROFIT Breakeven
Equity CDS (rhs)
September average
Barclays Capital | European Credit Alpha
1 October 2010 8
Figure 6: Healthcare, Retail, and Food & Beverages outperform the index in a downturn
Rsq of sector performance versus index to
GDP during downturn
Bond sector STOXX Index 2007-09 2001 1991 Average RSQ Average Beta
Healthcare SXDP 52% 27% 71% 50% -6.5
Retail SXRP 32% 68% 50% -6.3
Food & Beverage SX3P 45% 25% 25% 32% -1.9
Note: Regressions based on three-quarter performance of index versus SXXP against the percentage growth in GDP over the same three quarters. The period used are recessions as defined by the NBER, +/-2 quarters. Source: Bloomberg, Barclays Capital
Figure 7: Retail is a strongly counter-cyclical sector…
Figure 8: … as is Healthcare
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
Sep 06 Mar 07 Sep 07 Mar 08 Sep 08 Mar 09 Sep 09-5%
-4.%
-3%
-2%
-1%
0%
1%
2%
3%
Performance vs Index GDP
GDP growthSector performance vs Index
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
Sep 06 Mar 07 Sep 07 Mar 08 Sep 08 Mar 09 Sep 09-5%
-4.%
-3%
-2%
-1%
0%
1%
2%
3%
Performance vs Index GDP
GDP growthSector performance vs Index
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
Jun 99 Dec 99 Jun 00 Dec 00 Jun 01 Dec 01 Jun 020.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
Performance vs Index GDP
GDP growthSector performance vs Index
Source: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital
We suggest investors implement this view by selling protection on a basket of names from these sectors versus iTraxx Main – in a carry neutral format. As constituents for our basket, we prefer names our analysts hold a neutral or sell-protection view on, and that trade relatively wide versus the index (Figure 9). In particular we highlight Danone, Roche, Sodexo, Tesco, and Unilever.
Figure 9: The names we select are relatively far off their historical tights versus the index
Figure 10: This basket has outperformed during previous periods of poor growth
0.3
0.4
0.5
0.6
0.7
0.8
Jan07
Jul07
Jan08
Jul08
Jan09
Jul09
Jan10
Jul10
-5%-4%
-3%-2%-1%
0%1%2%
3%4%
Spread ratio of basket to yoy GDP growth,
0.3
0.4
0.5
0.6
0.7
0.8
Jan07
Jul07
Jan08
Jul08
Jan09
Jul09
Jan10
Jul10
-5%-4%
-3%-2%-1%
0%1%2%
3%4%
Spread ratio of basket to yoy GDP growth,
0.00
0.25
0.50
0.75
1.00
Danone
Roche
Sodexo
Tesco
Unilever
Basket
Ratio of CDS spread to iTraxx Main
Source: Markit, Barclays Capital Source: Markit, Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 9
DISTRESSED DEBT MARKETS
Time to grow We expect the European distressed debt market to grow as the result of excessive corporate leverage from the past decade. So far, the actual outflow of distressed assets from banks and non-bank investors has been relatively muted compared with the size of lending markets.
Eugene Regis +44 (0) 20 7773 9169
[email protected] A functioning distressed market is needed to value securities potentially seen as
stressed and restructure stressed corporates. For more distressed assets to be released to investors, the institutions that hold them may have to crystallise losses, but this should be balanced against regulatory capital being freed up as well as the prospect of achieving a higher price now and not being part of a restructuring process.
Sourcing distressed debt
We see the shakeout of the European leveraged finance market and forced sale of banking assets as the key contributors to the growth in distressed debt. So far, the distressed asset class has been slow to evolve despite the economic downturn for several reasons:
Some countries have created government sponsored frameworks to handle distressed assets in banks. This has allowed banks to either hive off bad loans into a government guaranteed “bad bank” (eg, NAMA in Ireland) or to keep them on balance sheet (eg, RBS benefitting from the APS scheme and Spanish Cajas benefitting from the FROB recapitalisation scheme) to be run off gradually.
Banking syndicates have also been generous in forbearance measures (covenant amendments and waivers), with many 2006-07 vintage LBOs also having fewer covenants to breach. This has reduced potential defaults, but if growth remains slow and corporates do not delever further, it remains to be seen if such measures continue.
European bankruptcy regimes tend to encourage liquidation of corporate rather than restructuring. This reduces potential recovery rates.
European distressed debt is much more of a private market compared with the US. If investors want to enter a special situation, they have to sign a confidentiality agreement to access private information and then learn about the situation before being able to build a position. By contrast, the US market is more public with investors being able to obtain public information more easily and start building a position ahead of any restructuring.
Over time, we expect these factors to change and the market to grow. For example, taxpayers may be reluctant to underwrite bad banks at a time of fiscal austerity; European bankruptcy rules may change; banking syndicates may prefer to restructure credits for a higher recovery now rather than risk a lower one in the future.
High-yield and leveraged loans There is a potential catalyst for growth in the distressed debt market as borrowers begin to hit maturity/amortisation points. The 2004-07 boom in lending showed falling underwriting standards, which we would expect to increase the chance of future restructurings. While defaults have increased into 2009, we would argue that decisions taken by banks and investors suppressed the default rate. We believe some defaults and restructurings that should have happened could yet still occur.
Barclays Capital | European Credit Alpha
1 October 2010 10
Figure 11: Distribution of deals by debt/EBITDA levels Figure 12: CCC volumes, percentage of HY issuance
0%
5%
10%
15%
20%
25%
30%
35%
97 98 99 00 01 02 03 04 05 06 07 08 09 100
1,000
2,000
3,000
4,000
5,000
6,000<3x 3.0-3.9x 4.0-4.9x 5.0-5.9x 6x and above CCC%
0%10%
20%30%40%50%
60%70%80%
90%100%
97 98 99 00 01 02 03 04 05 06 07 08 091H10
CCC Issuance, €mn (RHS)
Source: S&P LCD Source: Barclays Capital
Figure 11 shows covenant deterioration amongst leveraged loan borrowers, with an increasing proportion of deals being struck at leverage above 5x from 2001 to 2007. Similarly, for high yield bonds, CCC issuance also grew (Figure 12) as a proportion of the total. The falling proportion in 2006-07 should be taken in the context of record years for issuance1.
Prior issuance resulted in the maturity profile seen in Figure 13. While refinancing conditions were easy (eg, 2005-06 vintage loan deals being refinancing in 2006-07), this maturity mountain was easy to manage. The shutdown in the primary markets of 2008 halted this. Furthermore, for loans, the unwinds of TRS structures, market value CLOs and subsequent lack of new CLO issuance created difficulties for some borrowers.
However, the highest quality borrowers were able to refinance in the bond markets or even pursue IPOs. So far, c.70% of 2010 high yield bond issuance is for refinancing purposes, including private loan structures refinancing in the public bond markets. Figure 14 shows the change in maturity profiles. The extension in the loan space has been small relative to
Figure 13: Leveraged loan/high yield bond maturities (€bn)
Figure 14: Change in maturity profiles December 2008 to August 2010 (€bn)
0
5
10
15
20
25
30
35
40
45
50
10 11 12 13 14 15 16 17 18 19 20 >20
Institutional Lev. Loans HY Bonds
-6
-4
-2
0
2
4
6
8
10
12
14
10 11 12 13 14 15 16 17 >17
Loans Bonds
Source: S&P LCD, Barclays Capital Source: S&P LCD, Barclays Capital
1 CCC issuance in 2005 was €5.4bn in an €18.1bn total for the year. For 2006, there was €5.7bn of CCC product issued out of a €37bn total.
Barclays Capital | European Credit Alpha
1 October 2010 11
bonds. It is the poorer quality borrowers that have yet to extend their maturity profiles in the bond or loan markets who may face problems as they begin to hit maturity/amortisation deadlines. The length of time it takes to enter negotiations (eg, Gala took c.18 months to agree to a restructuring after being unable to meet amortisation payments) means that some borrowers may not have enough time to survive ahead of amortisations/final maturities. Some credits have bought time due to forbearance measures granted by lending syndicates (Figure 15
Figure 15: Distressed credits – defaults vs. restructurings
). This has led to a situation in which the volumes of amendments, though falling, are now higher in Europe than the US ( ). Figure 16
Figure 16: Issuers seeking covenant relief amendments
0
10
20
30
40
50
60
2004 2005 2006 2007 2008 2009 Jan-Aug 10
0
10
20
30
40
50
60
70
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10
US EuropeDefaults Restructurings Amendments
Source: S&P LCD Source: S&P LCD
Forbearance measures were granted because projected recoveries on credits would have been very low during the recession. If companies do not turn around after receiving covenant amendments, we would not expect banking syndicates to keep amending, especially for names close to maturity/amortisation payments. Also, given that banks are under pressure to hold onto more regulatory capital under Basel 3, they may be more incentivised to push names into restructuring and extract a higher recovery rather than seeing them default. European bankruptcy regulations make the default process more complex and generally results in a liquidation, which would lower recoveries. By contrast, the US has chapter 11 bankruptcy laws that keep a business as a going concern and arguably make the bankruptcy process faster than Europe2. A summary of US and European bankruptcy rules is in Figure 17.
Figure 17: European vs. US bankruptcy regimes
US Europe
Bankruptcy regime Single legal regime. Chapter 11 leads to re-organisation under operation as a going concern
No single bankruptcy provision. Some equity/ management friendly – France, Spain. Some secured lender friendly – UK, but it can be unfriendly to unsecured
Ease of coming through bankruptcy Well rehearsed. “Going concern” driven regime Not easy. Liquidation is frequent
Out of court restructuring Rare as restructuring is done through a bankruptcy court under Chapter 11.
Many restructurings to avoid a bankruptcy filing or avoid eventual liquidation. UK – most favourable
CDS consequences No restructuring on CDS in SNACs CDS trades with MMR under STEC
Default count consequences Easier to file and come through bankruptcy; hence, leads to higher default count
Difficult to file and come through so constrains default rate count
Source: Barclays Capital
2 Chapter 7 in the US is rarely used s it results in a liquidation and cessation of operations.
Barclays Capital | European Credit Alpha
1 October 2010 12
We also see increased Euribor rates as potentially prompting more restructurings. The low rate of Euribor has helped keep some credits alive, given that they are floating rate assets. The current rate is still well below the average for 2005-07 when such deals actually priced. Given that our rate strategists expect Euribor to increase to 2.05% by Q4 11 and growth to be slow, we believe some companies that are still underperforming by then may not be able to refinance if Euribor increases.
Figure 18: European rate history vs. leveraged loan issuance
02006 2007 2008 2009 2010
0
20
40
60
80
100120
140
160
180
200
€bn
1
2
3
4
5
6
%Non-Institutional InstitutionalEuribor (RHS) ECB Repo (RHS)Euribor Average by Year (RHS)
Source: Bloomberg, Barclays Capital
However, the leveraged finance market – at about €500bn outstanding – is only a part of the future distressed debt market. The bigger opportunity will be non-levered assets sitting on bank books from sectors affected in the recession, such as commercial property. The holders of such assets do not necessarily have the expertise to restructure them. By restructuring credits rather than liquidating them, distressed investors can extract value from stressed assets that previous classes of disparate holders could not. A recent example was Technicolor, which we discuss in the appendix.
Distressed loans at European banks We see potentially increased amounts of distressed debt coming from the banks over the medium term. The end result of Basel 3 is that bank assets will have to be better maturity matched with longer-term liabilities. Capital will come from a combination of new capital, increased deposits and, importantly, shedding assets, reducing the need to fund them. We note, however, that the 8-year implementation plan should mean fewer immediate forced sales of assets, thereby enabling more of them to be held to expected maturity if projected recovery prospects improve.
Not all banks will want to sell given the capital hit they may have to take. Most loan debt is held on the banking book and generally marked at par. If, for example, a senior loan is seen as intrinsically worth €70 and is still paying its coupon, a bank will not force a €30 loss by pushing for a restructuring – they would give a credit time to get a higher recovery or par. Despite this, there are certain circumstances that could force a bank to sell:
A bank itself becoming distressed (eg, Anglo Irish)
The bank thinks the ultimate recovery could be lower than the current value.
Barclays Capital | European Credit Alpha
1 October 2010 13
The reorganisation of the European banking sector is already resulting in asset sales for some banks across the EU. Conditional upon receiving EC approval of state aid, some banks are shrinking via asset sales over specified time frames. For example, we expect German landesbanks to be broadly net sellers of assets because they used their guaranteed balance sheets to build up assets in the past decade – some of which ended up as distressed.
Banks are trying varied solutions to dispose of distressed assets outside of traditional distressed debt investors. For example, a recent CLO from ICG saw €1.4bn of loans of varying credit quality exit the books of RBS with the equity tranche taking up 41% of the total deal. Existing CLOs will be hampered from investing in distressed, facing such rules as limits on CCC-rated positions and upcoming reinvestment period deadlines. Once past reinvestment periods, existing CLOs will have a lot less flexibility as they are forced to pay down their liabilities from loan amortisations and recoveries.
Assets from “bad banks”
The bailout of the banking system with public money could come under pressure. The bad banks created to buy banking assets at a discount need capital. Public finances across most EU nations have come under pressure. For example, France, Germany, Ireland, Italy and Spain have €2.5trn in maturities to fund through to 2015, with c.€500bn of this is from peripherals including Greece and Spain. The ability of countries to bail out their banking systems will link the creditworthiness of the banks to that of sovereigns.
The evolving textbook example is in Ireland following the end of the Celtic Tiger growth period. The current yield on the Irish 10-year benchmark has risen to c.6.7%, a level not seen since 1997. The cost of bailing out the Irish banking system to the government has risen combined with continuing austerity measures.
The government created the National Asset Management Agency (NAMA) to buy bank assets at a discount in exchange for government guaranteed bonds (which are eligible ECB collateral). NAMA can manage the assets to maturity or gradually sell them down to third-party investors. According to current plans, NAMA is expected to buy €81bn in impaired Irish bank assets, yet there is already evidence of continued deteriorating asset quality in the banking system since the bailout began. For example, in the case of Anglo Irish Bank, the haircuts offered by NAMA over the first two tranches have increased from 55% to c.62%. In the recent announcement, the haircut increased again to 67%. Such deteriorating asset quality could either lead to assets being forced out of banks without going to NAMA or to NAMA not being able to fund more impaired assets. A recent result of this is more active distressed trading in Irish credits such as Quinn Group.
Conclusion
A true market in European distressed securities will develop over time. We expect some poorly performing companies to be unable to refinance maturities and lending groups to be less willing to use forbearance measures. The larger proportion of distressed debt will be par bank loans, in our opinion, due to banks needing to delever and shed some assets ahead of Basel 3 implementation and bad banks potentially unwinding holdings of distressed loans. The size of the distressed market depends on the willingness of current asset holders to continue to crystalise losses now or later.
Barclays Capital | European Credit Alpha
1 October 2010 14
Appendix: Thomson/Technicolor case study The Technicolor restructuring is an interesting case study in how distressed credits can restructure after insolvency. It involved multiple classes of debt, hybrid equity and equity.
In July 2009, the company, which had been seen as in distress for some time, agreed to a restructuring proposal with its creditors. The pre and post restructuring capital structure is displayed in Figure 19
Figure 19: Technicolor (old Thomson) restructuring
. The restructuring saw debt and hybrid holders lose principal, with debt holders also getting extended and equity holders accepting dilution.
A debt for equity swap, the subsequent issue of an ORA instrument that payable as equity in December 2010 and 2011 and the pledging of disposal proceeds as a disposal note wiped out c.€1.3bn in debt. Technicolour also pledged disposal proceeds from various asset sales that were repayable in equity/cash. Following this, the new debt saw extended terms through to 2015-16 and the hybrid was stripped of its coupons after a payment of c.€0.05 to note holders (the hybrid is redeemed in full on any liquidation of the company and the payment avoided nuisance lawsuits).
Pre restructuring €mn Reinstated debt post restructuring €mn
Syndicated facility 1739 TL E+500bp, 7% amortising 306
Holders of the old syndicated facility received new loans and received equity/ORA Instruments/DPN rights. Debt and equity/ORA/Disposal notes valued at the same share as this class of debt in the old company. TL E+600bp 2016 bullet 643
Old private placement notes (PPN) 1100 Sr notes 9%/9.35%/9.55% $/£/€ amortising (new PPN) 194
Holders of the old PPNs received new PPN notes and equity/ORA Instruments/DPN rights. Debt and equity/ORA/Disposal notes valued at the same share as this class of debt in the old company.
Sr notes 9%/9.35%/9.55% $/£/€ bullet (new PPN) 407
Total debt* 2839 New term loans and senior notes are senior unsecured and pari passu Total reinstated debt 1550
Cash (511) Cash (400)
Hybrid 500 Hybrid bought out at €0.05
Net debt 2828 PF net debt 1150
Post restructuring Equity €
Rights issue (D/E swap) (350)
Equity price was €0.66 a share and fully underwritten by creditors via debt sell-off, open to shareholders.
ORA (D/E swap) 2010/11 10% PIK (639)
Issued to credits as debt for equity swap maturing in December 2010 and December 2011 with holders option to extend by one year. Company can repay 23% in cash.
Disposal note (10% PIK Dec 2010) (300)
Issued to creditors to be repaid from disposal proceeds and in shares of Thomson options at prevailing market price.
Reinstated debt 2015 1550
Note: * Restructuring plan used March 2009 FX rates, which differ from balance sheet numbers. Source: Company filings, Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 15
Debt recovery in this case (at time of restructuring) was c.55% for both the RCF and PPN holders (they were pari) before factoring in equity received under the debt for equity swap, ORA and rights to disposal proceeds under the disposal note. However, the original equity holders have been heavily diluted by the debt holders who received equity. The ultimate recovery for debtholders is also dependent on future equity and debt price direction in the restructured entity.
Rather than push through a liquidation that may have destroyed value, the restructuring has resulted in a more sustainable capital structure, reducing net debt to EBITDA to 2.4x, down from 4x at end-2008. Though interest cover has fallen to 3.8x from 6.3x over the same period, this reflects the current higher cost of capital traded off for a longer life of debt, also giving it extra ability to refinance further on if the credit story continues to improve.
Barclays Capital | European Credit Alpha
1 October 2010 16
CREDIT AT A GLANCE
Corporates generated just over 50bp of excess returns in September, led by financials – in particular the Tier 1 part of the capital structure. Insurance, which is more heavily weighted towards Tier 1 than banking, was the top performing sector this month – utilities underperformed.
Zoso Davies +44 (0) 20 7773 5815
Rob Hagemans +44 (0) 20 7773 6509
Dominik Winnicki +44 (0) 20 3134 9716
Indices were marginally tighter week on week, while investment grade cash was wider. Despite this, our measure of the cash-CDS basis was broadly unchanged as single-name contracts lagged the index tightening. This drove the skew more negative on Main and Crossover. Index curves steepened, but only marginally, and slopes remain near the top of their historical ranges. High-yield cash continues to outperform, while sterling cash underperformed and now looks cheap to USD-credit on a historical basis.
September issuance was the third highest monthly total this year, but average by historical measures – and significantly below the USD100bn of new deals in the US market. Financials issued c.EUR30bn of debt and non-financials c.EUR20bn, of which c.EUR5bn was hybrid debt.
Figure 20: Barclays Capital Euro Aggregate Corporate Index performance by sector
Sector MTD excess returns (%) 29 Sept OAS(bp) 21 Aug OAS(bp)
m/m spread change
Excess return 3mth (%)
Excess return 12mth (%) % of index
Insurance 2.19 331 367 -36 4.7 5.4 5.2
Brokerage 0.82 266 280 -13 1.5 5.2 0.2
Banking 0.77 231 244 -13 2.4 1.7 42.1
Senior 0.14 173 172 1 1.2 0.2 30.2
Lower Tier 2 1.30 292 324 -32 3.5 3.6 8.2
Upper Tier 2 0.98 441 447 -6 2.8 4.7 0.7
Tier 1 5.77 603 705 -102 12.5 10.7 3.0
Transportation 0.72 203 214 -11 -0.4 2.8 2.0
Capital Goods 0.51 173 179 -6 1.3 2.5 4.8
Basic Industry 0.49 152 158 -6 1.2 2.3 3.9
REITS 0.35 172 177 -5 1.0 3.8 0.4
Finance Companies 0.35 203 206 -3 1.5 3.4 2.9
Other Finance 0.34 265 279 -14 1.5 2.4 0.5
Technology 0.27 148 149 0 1.0 1.9 0.6
Consumer Cyclical 0.16 143 140 3 1.1 2.7 6.3
Natural Gas 0.09 148 143 5 0.9 0.0 1.9
Consumer Non-Cyclical 0.08 112 110 2 0.7 1.9 8.9
Other Utility 0.02 134 122 12 0.7 2.5 1.4
Energy 0.00 104 101 3 1.2 0.6 3.0
Communications -0.01 161 158 3 1.1 1.0 9.5
Electric Utility -0.13 140 126 14 0.5 0.3 5.9
Financials 0.88 240 254 -14 2.6 2.2 51.4
Corporates 0.52 193 199 -6 1.7 1.9 100.0
Source: Barclays Capital
Barclays Capital | European Credit Alpha
Figure 21: CDS indices tightened this week… Figure 22: … but spreads remain in a narrow range
1 October 2010 17
-6
-5
-4
-3
-2
-1
0
1
2
Main
HiV
ol
Crossover
Sen. Fins
Sub. Fins
SovX
w/w spread change (bp)
0
100
200
300
400
500
600
2007 2008 2009 2010 20110
200
400
600
800
1000
1200Main (111)SovX (156)Sen. Fins (144)HiVol (175)Crossover (513)
Main, Sen.Fin,SovX, HiVol (bp)
Crossover (bp)
Note: Spread changes measured between Wednesdays. Source: Markit Source: Markit
Figure 23: In cash, IG spreads widened while HY tightened
Figure 24: HY spreads have outperformed year to date
-20-15-10
-505
1015202530
Sen. Fins
LT2
Tier 1
Financials
Industrials
Utilities
Pan EurH
Y Index
HY 3%
ex.Fins
w/w spread change, bp
0
50
100
150
200
250
300
350
400
2007 2008 2009 2010 20110
200
400
600
800
1000
1200
1400
1600
1800
Sen. Financials (173) Non-Fins (144)Sub. Financials (377) Pan Eur HY Index (525)
IG, OAS (bp) Sub. Fins, HY, OAS (bp)
Note: Spread changes measured between Wednesdays. Source: Barclays Capital Source: Barclays Capital
Figure 25: USD cash outperformed this week
Figure 26: Sterling credit looks cheap to USD, historically
0
2
4
6
8
10
12
14
EUR GBP USD
w/w spread change, bp
0
100
200
300
400
500
600
700
2007 2008 2009 2010
EUR (155)GBP (199)USD (172)
BBB non-financials, L-OAS
Note: Spread changes measured between Wednesdays. Source: Barclays Capital Source: Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 18
Figure 27: Basis was broadly unchanged this week Figure 28: The sub-fins basis continues to normalise
-8-6-4-202468
10€
IG n
on-
fins
£ IG
non
-fin
s
€ IG
sen
-fin
s
€ IG
sub
-fin
s
Hig
h Yi
eld
w/w change in basis, bp
94
48
-27-16
-200
-150
-100
-50
0
50
100
Aug 09 Nov 09 Feb 10 May 10 Aug 10
€ IG non-fins € IG sen-fins High Yield£ IG non-fins € IG sub-fins
cash-CDS Basis, bp
Source: Markit, Barclays Capital Source: Markit, Barclays Capital
Figure 29: September has been the third busiest month, YTD
Figure 30: HY issuance picked up late in the month
0
20
40
60
80
100
120
Sep
Oct
Nov
Dec Jan
Feb
Mar
Apr
May Jun
July
Aug
Sep*
2009 2010
Financials Non-Financials
IG Issuance, EUR bn *, Issuance MTD
0
2
4
6
8
10
Sep
Oct
Nov
Dec Jan
Feb
Mar
Apr
May Jun Jul
Aug
Sep*
2010
Monthly Issuance
HY Issuance, €bn *, Issuance MTD
Source: Dealogic, Barclays Capital Source: Dealogic, Barclays Capital
Figure 31: Implied vol took another leg lower this week
Figure 32: Realised volatility continues to trend lower
43%
66%
30%
40%
50%
60%
70%
80%
90%
100%
110%
Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10Realised Implied
Annualised
20%
40%
60%
80%
100%
120%
140%
Jan09
Apr09
Jul09
Oct09
Jan10
Apr10
Jul10
Main (43%)HiVol (52%)Crossover (50%)SenFin (57%)SovX (52%)
Source: Markit, Barclays Capital Source: Markit, Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 19
Figure 33: Curves steepened marginally this week Figure 34: Index 3s5s remain near historical highs
0
1
2
3
Main 3s5s Main 5s10s XO 3s5s XO 5s10s
w/w spread change, bp
-250
-200
-150
-100
-50
0
50
100
150
2006 2007 2008 2009 2010 2011-50
-40
-30
-20
-10
0
10
20
30
XO 3s5s (76)XO 5s10s (5)Main 3s5s (27)Main 5s10s (11)
Crossover slope, bp Main slope, bp
Source: Markit, Barclays Capital Source: Markit, Barclays Capital
Figure 35: Credit and equities remain range-bound
Figure 36: Cross-asset beta and correlation have stabilised
600
1100
1600
2100
2600
3100
3600
4100
4600
5100
5600
0 100 200 300 400 500
2000-2007 Cycle2007-2009 Cycle2009-PresentCurrent Spread
Stoxx 50
Barclays Capital EUR Agg. cash index (OAS)
-0.15
-0.10
-0.05
0.00
0.05
0.10
0.15
2002 2004 2006 2008 2010-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
Beta, BarCap Eur. Agg. Corp OAS to SX5PCorrelation, BarCap Eur. Agg. Corp OAS to SX5P
90 day Betaof w/w changes
90 day Correlation of w/w changes
Source: Markit, Bloomberg, Barclays Capital Source: Markit, Bloomberg, Barclays Capital
Figure 37: Skew on Main turned negative this week…
Figure 38: … but was broadly unchanged on Crossover
-3.0-4-2
02
46
810
1214
16
Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10
Skew of Main 25 day rolling average
Skew (bp)
9.6
-10
0
10
20
30
40
50
Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10
Skew of Crossover 25 day rolling average
Skew (bp)
Source: Markit, Barclays Capital Source: Markit, Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 20
Returns
Figure 39: Barclays Capital Euro Aggregate Corporate Index – performance by rating and maturity
MTD excess returns (%)
29 Sept OAS(bp)
21 Aug OAS(bp)
m/m spread change
Excess return 6mth (%)
Excess return 12mth (%) % of index
Rating
Aaa 0.02 100 99 1 0.2 -0.3 3.2
Aa 0.16 137 136 1 1.1 0.9 22.5
A 0.50 188 196 -8 1.7 1.9 49.4
Baa 0.95 267 275 -8 2.6 3.4 24.9
Maturity
1-3y 0.46 185 196 -12 0.3 1.9 29.3
3-5y 0.49 195 200 -4 -0.3 1.7 31.3
5-7y 0.66 199 202 -3 -0.8 2.7 19.1
7-10y 0.72 214 215 -1 -1.6 1.9 14.4
10y+ -0.01 158 157 1 -2.6 2.1 5.9
Source: Barclays Capital
Figure 40: 2010 July total returns, Pan European 3% High Yield Index
Total return (%) Δ OAS (bp)
Jul 2010 YTD LTM OAS (bp)
MAD (yrs)
OAS/ MAD Jul 2010 YTD
% Creditindex
Overall 3.2 9.3 23.9 530 3.9 134 -84 -38 100.0
Ba 2.4 8.0 18.1 388 4.0 96 -65 12 57.8
B 3.6 9.3 21.5 620 4.1 152 -93 16 29.6
Caa 5.3 15.6 51.5 902 3.2 281 -159 -198 11.9
Ca-D 13.0 -0.3 62.4 2065 3.6 575 -243 168 0.7
0-3y 1.9 6.8 18.8 439 1.8 238 -100 -125 24.2
3-4y 2.9 8.7 24.7 584 3.3 175 -86 -37 24.4
4-5y 4.6 11.6 27.6 639 4.4 146 -126 34 21.4
5-6y 3.7 10.0 24.4 490 5.4 91 -37 -18 21.9
6y+ 2.6 10.5 25.7 463 7.1 66 -64 27 8.1
Energy 5.7 12.6 17.1 417 5.3 79 -125 -76 0.7
Electric 5.7 13.7 20.3 472 5.2 91 -138 -71 0.8
Technology 5.1 18.8 25.2 605 3.9 153 -123 -112 1.8
Transportation 4.1 10.0 26.8 458 4.0 115 -109 -32 5.3
Communications 3.7 6.9 20.8 663 4.5 149 -92 36 20.8
Basic Industry 3.4 11.3 32.7 543 3.7 145 -81 -140 16.8
Other Industrial 3.1 11.0 27.1 606 4.0 152 -91 15 4.8
Capital Goods 2.8 7.4 25.5 513 3.9 130 -92 -21 15.3
Consumer Non-Cyclical 2.7 8.6 15.1 366 4.3 84 -64 -8 8.9
Consumer Cyclical 2.6 10.1 23.3 482 3.4 142 -73 -69 24.7
Other utility -0.9 8.0 6.2 350 6.3 56 11 130 0.2
Source: Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 21
Index volatility update
Figure 41: Realised volatility keeps dropping
Figure 42: Payer skew edged up as risk aversion increased
0%
20%
40%
60%
80%
100%
120%
Sep09
Nov09
Jan10
Mar10
May10
Jul10
Volatility
-0.05
0
0.05
0.1
0.15
0.2Skew
0
20
40
60
80
100
120
140
160
Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug
Volatility (%)
3M Implied 3M Realised 1M Realised3M ATMf implied vol Receiver skew (rhs)Payer skew (rhs)
Source: Barclays Capital Source: Barclays Capital
Figure 43: Main volatility still in a downward trend
Figure 44: Credit volatility falling versus other asset classes
0.5
0.7
0.9
1.1
1.3
1.5
1.7
1.9
Jan Feb Mar Apr May Jun Jul Aug Sep
Normalized volatility
50
55
60
65
70
75
80
85
90
30/06/2010 30/07/2010 30/08/2010
Volatility (%)
50
55
60
65
70
75
80
Volatility (%)
Main 3M ATM IG 3M ATM (rhs) Main SX5E EUSW5 EURUSD
Source: Barclays Capital Note: 3m implied volatilities normalised to 4 January level. EUSW5 represents 3m implied volatility in 5y swaptions. Source: Bloomberg, Barclays Capital
Barclays Capital | European Credit Alpha
1 October 2010 22
EUROPEAN CREDIT RESEARCH ANALYSTS
Matthew Leeming Credit Strategy +44 (0)20 7773 9320 [email protected]
Zoso Davies Credit Strategy +44 (0)20 7773 5815 [email protected]
Arup Ghosh Credit Strategy +44 (0)20 7773 6275 [email protected]
Rob Hagemans Credit Strategy +44 (0)20 7773 6509 [email protected]
Eugene Regis Credit Strategy +44 (0)20 7773 9169 eugene.regis@ barcap.com
Aziz Sunderji Credit Strategy +44 (0) 20 7773 7881 [email protected]
Dominik Winnicki Credit Strategy +44 (0)20 3134 9716 [email protected]
Robert Jones Head, European Fundamental Credit Research +44 (0)20 7773 9857 [email protected]
Neil Beddall Utilities +44 (0)20 7773 9879 [email protected]
Darren Hook Industrials +44 (0)20 7773 8970 [email protected]
Jeroen Julius Banks +44 (0)20 3134 9642 [email protected]
Brian Monteleone Insurance +44 (0)20 3134 9685 [email protected]
Sam Morton High Grade TMT +44 (0)20 7773 7844 [email protected]
Justin Ong Consumer/Retail +44 (0)20 3134 9687 [email protected]
Daniel Rekrut High Yield TMT +44 (0)20 7773 5980 [email protected]
Analyst Certification(s) We, Matthew Leeming, Zoso Davies, Arup Ghosh, Eugene Regis, Aziz Sunderji and Dominik Winnicki, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-bin/all/disclosuresSearch.pl or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise. Explanation of the High Yield Sector Weighting System Overweight: Expected six-month total return of the sector exceeds the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index, or the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, as applicable. Market Weight: Expected six-month total return of the sector is in line with the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index or the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, as applicable. Underweight: Expected six-month total return of the sector is below the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index or the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, as applicable. Explanation of the High Yield Research Rating System The High Yield Research team employs a relative return based rating system that, depending on the company under analysis, may be applied to either some or all of the company's debt securities, bank loans, or other instruments. Please review the latest report on a company to ascertain the application of the rating system to that company. Overweight: The analyst expects the six-month total return of the rated debt security or instrument to exceed the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Market Weight: The analyst expects the six-month total return of the rated debt security or instrument to be in line with the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Underweight: The analyst expects the six-month total return of the rated debt security or instrument to be below the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Not Rated (NR): An issuer which has not been assigned a formal rating. Rating Suspended (RS): The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company.
This publication has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. This publication is provided to you for information purposes only. Prices shown in this publication are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell any financial instrument. Other than disclosures relating to Barclays Capital, the information contained in this publication has been obtained from sources that Barclays Capital believes to be reliable, but Barclays Capital does not represent or warrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject to change, and Barclays Capital has no obligation to update its opinions or the information in this publication. The analyst recommendations in this report reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any other interests, including those of Barclays Capital and/or its affiliates. Neither Barclays Capital, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. The securities discussed in this publication may not be suitable for all investors. Barclays Capital recommends that investors independently evaluate each issuer, security or instrument discussed in this publication and consult any independent advisors they believe necessary. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information in this publication is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results. This communication is being made available in the UK and Europe primarily to persons who are investment professionals as that term is defined in Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons who have professional experience in matters relating to investments. The investments to which it relates are available only to such persons and will be entered into only with such persons. Barclays Capital is authorized and regulated by the Financial Services Authority ('FSA') and member of the London Stock Exchange. Barclays Capital Inc., US registered broker/dealer and member of FINRA (www.finra.org), is distributing this material in the United States and, in connection therewith accepts responsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Barclays Capital Inc. in the U.S. at 745 Seventh Avenue, New York, New York 10019. Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless local regulations permit otherwise. This material is distributed in Canada by Barclays Capital Canada Inc., a registered investment dealer and member of IIROC (www.iiroc.ca). Subject to the conditions of this publication as set out above, Absa Capital, the Investment Banking Division of Absa Bank Limited, an authorised financial services provider (Registration No.: 1986/004794/06), is distributing this material in South Africa. Absa Bank Limited is regulated by the South African Reserve Bank. This publication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory and Intermediary Services Act, 37 of 2002, or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. Any South African person or entity wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Absa Capital in South Africa, 15 Alice Lane, Sandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays Capital. In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed to institutional investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 6-10-1 Roppongi, Minato-ku, Tokyo 106-6131, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firm regulated by the Financial Services Agency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143. Barclays Bank PLC, Hong Kong Branch is distributing this material in Hong Kong as an authorised institution regulated by the Hong Kong Monetary Authority. Registered Office: 41/F, Cheung Kong Center, 2 Queen's Road Central, Hong Kong. Barclays Bank PLC Frankfurt Branch is distributing this material in Germany under the supervision of Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin). This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd. This material is distributed in Brazil by Banco Barclays S.A. Barclays Bank PLC in the Dubai International Financial Centre (Registered No. 0060) is regulated by the Dubai Financial Services Authority (DFSA). Barclays Bank PLC-DIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence. Barclays Bank PLC in the UAE is regulated by the Central Bank of the UAE and is licensed to conduct business activities as a branch of a commercial bank incorporated outside the UAE in Dubai (Licence No.: 13/1844/2008, Registered Office: Building No. 6, Burj Dubai Business Hub, Sheikh Zayed Road, Dubai City) and Abu Dhabi (Licence No.: 13/952/2008, Registered Office: Al Jazira Towers, Hamdan Street, PO Box 2734, Abu Dhabi). Barclays Bank PLC in the Qatar Financial Centre (Registered No. 00018) is authorised by the Qatar Financial Centre Regulatory Authority (QFCRA). Barclays Bank PLC-QFC Branch may only undertake the regulated activities that fall within the scope of its existing QFCRA licence. Principal place of business in Qatar: Qatar Financial Centre, Office 1002, 10th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 15891, Doha, Qatar. This information is distributed in Dubai, the UAE and Qatar by Barclays Bank PLC. Related financial products or services are only available to Professional Clients as defined by the DFSA, and Business Customers as defined by the QFCRA. This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the Publication to be used or deemed as recommendation, option or advice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No. 09141-37). Registered office Al Faisaliah Tower | Level 18 | Riyadh 11311 | Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number: 1010283024. This material is distributed in Russia by Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker License #177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21. IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor. © Copyright Barclays Bank PLC (2010). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of Barclays Capital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publication will be furnished upon request. EU14878