BarCap on Distressed Debt Markets

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1 October 2010

EUROPEAN CREDIT ALPHA More answers than questionsMatthew Leeming +44 (0) 20 7773 9320 Zoso Davies +44 (0) 20 7773 5815 Arup Ghosh +44 (0) 20 7773 6275

This version corrects Figure 3, where the scale was incorrect on the left hand axis.Eugene Regis

Strategic Market View: There and back again


+44 (0) 20 7773 9169 Aziz Sunderji +44 (0) 20 7773 7881 Dominik Winnicki +44 (0) 20 3134 9716

Driven by mixed signals from the economic and political front credit spreads seesawed 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


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 Europes 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


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


THESISMonetise steep skew, hedge against moderate widening Use bank Tier 1s to boost yield or beta Relative value in step-up bonds Relative value trades between corporates and sovereigns Cyclical hedge in CDS Normalisation trades

TRADE IDEAS1x2 payer spreads on Main to December 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 Switch into Lafarge step-ups: LGFP 7.625% 2014 and LGFP 7.625% 2016s Short corporates trading tighter than their own sovereign (only in AAA sovereigns)

High Yield

Relative value across ratings buckets Relative value in senior vs subordinated cash

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 Yield/credit curves steep at front end, buy short-dated credit Basis trades > -100bp We favour single-B-rated paper and expect it to compress towards BB 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 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 We favour bonds with cash yield above the current yield of the index 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 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 Long equity call options for LBO candidates

Trades on issuers we expect to refinance Returns are hard to find Event-driven trades: LBOs Cash


Equity options

HIGH GRADE CREDIT RESEARCH SECTORS COMPANIESAutos Banks Consumer & Retail General Industrial Insurance Pharmaceuticals TMT

OVERWEIGHTBanks, Consumer, Industrials

UNDERWEIGHTTelecoms, Media, Technology, Utilities, Pharmaceuticals



BMW (CDS), Daimler (CDS) RBS (cash), Commerzbank (cash), UniCredit (cash) Accor (cash), Kingfisher (cash), Rentokil (cash), Metro, BAT, Imperial Tobacco, Tesco (CDS), PPR (CDS) BAA (cash), Finmeccanica, Alstom (CDS), CRH, Clariant (cash), Thyssenkrupp (CDS) Stalif (cash), Llydin (T1), Eureko (bonds), Munich Re (bonds), Zurich (bonds) Roche, Novartis (cash) BT Group, OTE, Telefonica, Lagardre, Swisscom (CDS), Telenor (CDS), Nokia (CDS) EDP, Enel, Gas Natural, Veolia Environnement, REN, Glencore, Iberdrola (CDS)

BMW (cash), VW (cash), Volvo (cash), Michelin (cash) Allied Irish Banks (cash), BCP (cash), BES (cash), Dexia (cash), Monte dei Paschi (cash) Carrefour, Next (CDS), Diageo, Experian (CDS), Carlsberg (CDS) Metso, Akzo Nobel, Bayer, Clariant (CDS), Rolls Royce (CDS), Lafarge, Sanofi-Aventis, Holcim (cash) Aegon (CDS), Hannover Re (CDS), Generali (CDS), Unipol (CDS) AstraZeneca Deutsche Telekom, Vodafone, TeliaSonera, TKA, KPN, STM (CDS), FT, Ericsson, Pearson** (CDS), Portugal Telecom (CDS), Wolters Kluwer (CDS), Ericsson (CDS), WPP (CDS) United Utilities Plc, Suez Environnement, Elia, Verbund, Edison, Fortum (CDS), EnBW (CDS), Vattenfall (CDS)





Consumer & Retail TMT

Ardagh Glass 2016/2017/2020, Lecta 2014 (sub + snr), M-Real 2013, Smurfit Kappa Group 2015/2017/2019 Evonik Degussa 13s, Evonik Industries 14s, Savcio, HeidelbergCement 2012/2014/2017/2018/2019, Valeo (cash), GKN (CDS) Pernod (EUR) Wind 11.0% 2015, KDG +700 PIK 2014, Seat 8.0% 2014, Unity 8.125% 2017, UPC 8.0% 2016

Clondalkin Industries 2013/2014, Norske Skog 17s Lufthansa (cash), Air France (cash), Stora Enso, UPM

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

1 October 2010


Barclays Capital | European Credit Alpha

REPORTING CALENDARNext WeekDate Mon, 4 Oct Company Release/event Economic data US: Pending home sales, Factory orders EZ: Sentix, PPI UK: Construction PMI US: ISM non-Manufacturing EZ: Retail sales, PMI UK: Services PMI US: ADP employment report EZ: Q2 GDP (Final) GE: Factory orders US: Consumer credit, Jobless claims EZ: ECB Rates decision GE: IP UK: NIESR GDP Estimate, BoE rates decision, IP US: Non-farm payrolls, Unemployment, Wholesale inventories GE: Trade balance UK: PPI

Tue, 5 Oct

Tesco Tui Travel Sainsbury

H1 interim results Interim sales Q2 sales

Wed, 6 Oct

Thu, 7 Oct


Q2 sales

Fri, 8 Oct

Source: Bloomberg, company reports, Barclays Capital

The week afterDate Mon, 11 Oct Company Securitas Sodexo Ladbrokes Release/event 9M results FY results Interim trading update US: FOMC Minutes, Small business optimism GE: CPI UK: Trade balance, RPI, CPI US: MBA Mortgage applications, Budget EZ: IP UK: Unemployment report US: PPI, Jobless claims, Trade balance, EZ: ECB Monthly report Economic data

Tue, 12 Oct

Wed, 13 Oct


Q3 sales (after mkt)

Thu, 14 Oct

Carrefour Diageo Roche SABMiller Suedzucker Syngenta

Q3 sales Interim statement Q3 sales Q2 sales Q2 results Q3 sales

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

1 October 2010


Barclays Capital | European Credit Alpha


There and back againArup 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

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 t


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