09.06.17

Snapshots was up all night watching the UK election results roll in

The result was a surprise.  However, this morning the Conservative Party reached agreement with the Democratic Unionist Party of Northern Ireland to form a minority government which should mean a soft Brexit stance with the EU.   We think this explains the muted reaction in the FX, rates, credit and equity markets this morning.

Banco Popular

The other surprise in the markets this week was the decision by the Single Resolution Board to trigger the resolution of Banco Popular as it was mid-way through a process of repairing its capital and looking for a strategic buyer.  The decision was based on the ECB’s conclusion that the bank had reached a point of non-viability due to deposit outflows.  The speed and apparently arbitrary nature of the decision shocked the market.  Spanish ministers are happily pointing out that taxpayers did not have to pay for a rescue and furious investors are saying the bank was expropriated.  Expect a number of legal suits to be filed.

We believe the strength of the Spanish economy allowed such a quick resolution decision to be made and worked against Popular.  We are already seeing some unintended consequences.  Investors are changing their assumptions on regulator behaviour and the impact of any intervention.  Risk premia of mid-sized peripheral banks with any asset quality or capital issues are increasing as the capital markets have had the door closed on them.  The broader market reaction has been minimal.

Covenants

Snapshots attended a very illuminating session on European leveraged covenants this week.  Did you know that the amount of debt issuers can incur is now based on volatile EBITDA as opposed to more stable Net Asset Values?  Also, unrestricted payments are now subject to a leverage test only which used to be the sole preserve of investment grade issuers.  And covenants can be tested on EBITDA with add-backs included for revenue and cost synergies.  The details behind these add-backs can be vague and only need to be certified by the CFO on a compliance certificate once a year.

There aren’t any immediate implications other than extreme issuer discrimination is more important as this credit cycle matures.

Barcelona Conference

There was a distinctly upbeat mood at the Barcelona conference this week as delegates sipped cheap cava in fancy flutes.  The main theme to emerge was a lack of investable public market opportunities as central bank activity has effectively removed the need for bank issuers of prime paper to come to the market.  The asset class still screens well on a relative value basis, a theme we have highlighted for some time.  Delegates also noted a boom in private market transactions being originated by the non-banking sector.

By Asif Godall
Deputy CIO