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After cautious optimism, worry and patience, comes fatigue...
The second quarter has begun with the financial markets posting near-zero returns for all asset classes but at the cost of volatility. The mood of asset managers seems to change regularly: 1/ relative confidence at the beginning of the year, fed by the feeling of many players that they were cautiously positioned, 2/ doubt at the end of January due to unusually sharp spikes in volatility and losses of between 2 and 10% in bond and stock portfolios, 3/ patience since mid-February, necessitated by a complete absence of a trend and growing uncertainty on the economy and geopolitics, 4/ the fatigue that is setting in now.
As we have often stated, the economy, politics and central banks do not have the same rhythm or tempo as the financial markets. One has a decade-long horizon, the others a few months at best and a few milliseconds at worst. In situations such as the one which we are currently facing, with volatility having caused massive stress for portfolio managers but with no performance to show for it, it is increasingly difficult to maintain the level of patience required, given this creeping sense of fatigue. Portfolio managers are questioning their ineffective arbitrage positions and their new, increasingly exotic investment strategies. However, given that most assets are trading at exactly the same level as at the beginning of the year, and as the economic outlook has not changed much in 3 months, there is no reason to make even the slightest change to positions.
Contrary to what is being said by underperforming investment managers and sales types looking to boost fund flows, the caution which was present at the beginning of the year must be maintained. No increase in high yield weightings, which have slowly begun to slip lower and which could signal an equity correction, as they did in late 2015/early 2016; no increase in interest rate sensitivity – interest rates have yo-yoed and come back to their lowest levels of end 2017/early2018; no increase to exposure to the riskiest bond categories like private debt or new bank Tier 1 debt (AT1/cocos) as these categories offer small premiums relative to long term average interest rates. The German 10 yr yield, when it increases, is not going to get much past 2-3%. How is it in the interest of new investors to buy totally illiquid debt or preferred shares to make a profit of 4-5%? It isn’t, and so the repricing begins. While many investors are currently happy that illiquidity in the private debt market or in even more exotic securities means a lack of volatility (for the simple reason that there is no market for these instruments) the reckoning may turn out to be comparable to what investors who put their savings into the CDOs, CLOs and other loan securitizations of small and medium-sized companies, encountered in 2007. The banks, who have not had a dog in this fight since the crisis, are now taking great care to craft prospectuses which will protect them from litigation and other fallout. And so, history repeats itself indefinitely and more quickly in finance than elsewhere. This week, CGG and Softbank were front and center in the credit markets:
1/ Let us briefly consider CGG’s history. The group was once a French technology jewel, considered to be a strategic company as the government held a 10% stake via the public investment bank (BPI).
At the end of 2015, CGG management could see a cash crunch coming and began a debt restructuring using a method characteristic of American issuers: negotiations with pools of creditors. Rather than make the same offer to all bondholders, CGG proposed to the holders of the 2017, 2021 and 2022 dollar bonds that they exchange their bonds for a loan. Not so unusual until you get to the fine print which said that the loan was guaranteed by the majority of the group’s assets. The holders of the new loan, mostly Americans, found that they had effectively become senior to the holders of the euro bonds – mostly Europeans!
Having broken its covenants at the end of 2016, CGG began a restructuring process at the beginning of 2017.  A large dichotomy had appeared between the issuer’s dollar and euro bonds: the infamous dollar loans were trading at 100% of nominal while the euro bonds, which were never exchanged, traded at 40-50% of nominal.
At the beginning, all creditors ranked pari passu, meaning they all had the same level of seniority. This was before CGG favoured certain creditors and made them more senior than others. At the end of 2017, the issuer completed its restructuring process by exchanging its bonds for stock but following in the footsteps of other not-so-solid issuers, like Solocal, CGG was not finished with debt and needed to find new creditors to finance its losses. Naturally, CGG did not at first dare to return to the European markets for financing. No doubt, it was still too soon after the shameful imbroglio, which clearly ran counter to the concept of treating creditors equally. So CGG completed the almost $1.5bn dollar equivalent issue in the US market under the new name “CGG Holding US Inc.” at coupons between 7.8 and 9%.
We should keep in mind that the coupon level is irrelevant if it isn’t paid and CGG has not shown itself to be trustworthy these past few years (much like its accomplice Bourbon, another French “jewel” that is expected to suspend soon the coupon payment on its subordinated hybrid bond and is also expected to proceed with a punishing restructuring). We noted above that history repeats itself and we expect to see CGG in difficulty again, requiring another restructuring in the coming few years (or months).
2/ The other story is that of Softbank. The group discreetly announced early last week that it has borrowed the equivalent of $8 billion by way of a loan guaranteed by Alibaba shares. With $140 billion in debt, Softbank makes Altice look like an amateur and after so many good years for telecom operators we would question the group’s solidity and wonder whether its appetite for gargantuan debt-fueled acquisitions won’t lead it into the bond market abyss. Not only is its business becoming less profitable due to the massive spending needed to maintain its network, but new acquisitions made through a ~$100 million private equity fund are at times hazardous, risky and questionable in terms of strategy and synergies (Brightstar in retailing, Uber, Yahoo! Japan) which creates a dangerous scissor effect in the context of leverage at approximately 4x. The new loan, guaranteed by shares (margin loan) which will not appear on the financial statements nor in debt, despite its significant size. Clearly, having to resort to risky loans and accounting tricks is indicative of how difficult the situation is for Softbank. It is also a reminder of another company which had eyes bigger than its stomach and ended up with indigestion: Steinhoff.


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