JUNK BONDS

Traders Pile Into Cheap Thames Water Bonds on Restructuring Bet

Tasos Vossos, Neil Callanan and Abhinav Ramnarayan
Thu, April 11, 2024





(Bloomberg) -- Money managers are buying up Thames Water bonds that are trading well below their face value, betting that any haircut from a potential restructuring will prove less painful than current trading levels indicate, according to people with knowledge of the matter.

The wager sees investors buy the operating company’s lowest-priced top-tier bonds, which trade at a discount of about 20% or more to the issuance price because of their lower coupon, the people said, asking not to be named. The popularity of the trade has helped the bonds outperform their higher-price counterparts in recent days.

To hedge against the bet not paying off, some investors are also short selling bonds that trade close to face value, the people said.

Holders of Thames Water’s £16 billion ($20.1 billion) of debt are bracing for a potential haircut after the firm’s parent company, Kemble Water Holdings Ltd, defaulted last week. The government is resisting pressure to bring the UK’s biggest water company into special administration, but creditors are concerned that some kind of restructuring is becoming more likely amid a deepening standoff between Thames shareholders and the water regulator Ofwat.

Special administration, a form of temporary nationalization, would likely lead to a debt reorganization which could see senior bondholders having to take a haircut, analysts at CreditSights wrote in a note on Tuesday.

“We have, in the last few weeks, moved some of the higher cash price bonds into lower cash price bonds from a prudent risk management perspective,” said Luke Hickmore, a portfolio manager at Abrdn Investment Management Ltd. His base case is that Thames Water will eventually receive an equity injection.

Short interest has risen sharply in three high-price Thames Water bonds, an indicator of the size of bets against them. In one case, involving a bond maturing in 2028, the wagers now amount to almost 18.5% of the percentage value at issuance, compared to 1.26% at the start of the year, according to data compiled by S&P Global Market Intelligence. By contrast, bets against three low-price bonds remain below 1.4%.

Companies with large amounts of debt often have bonds with wildly differing cash prices because notes are issued over multiple years at different points in the rate cycle. The average coupon size on the lower-price Thames bonds is about 200 basis points below that of the firm’s other debt.

This disparity can become a trading opportunity when an unexpected redemption occurs. In the case of Thames Water, investors are betting that bonds will be redeemed at around 70-85 cents per pound if the company is placed under special administration. This makes any bonds with a cash price below that look attractive, and anything above look expensive. A 100 basis point gap has opened up between the valuations of the two groups of bonds in recent days.

Thames Water’s parent company, Kemble Water Finance Limited, defaulted on about £1.4 billion ($1.8 billion) of debt last week after shareholders refused to provide £500 million of fresh equity. Tight legal and regulatory frameworks mean Thames Water can operate on its own, but a group of creditors at the operating company have hired advisors for help on potential restructuring talks anyway.

CreditSights analysts Helen Rodriguez and Andrew Moulder outlined six different scenarios for the saga at Thames Water, ranging from an eventual equity injection to a break-up of the business. Bloomberg Intelligence analyst Paul Vickars wrote in a note last week that the firm may require a haircut of at least 20% on its Class A debt to comply with Ofwat’s regulations.

--With assistance from Laura Benitez.

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