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SVU Valens Credit Analysis – Operational sustainability, capex flexibility, and moderate recovery rate indicate that ratings agencies and credit markets are overstating fundamental credit risk
March 2, 2018
CDS markets are materially overstating credit risk with a CDS of 692bps relative to an Intrinsic CDS of 479bps, while cash bond markets are overstating credit risk with a cash bond YTW of 8.460% relative to an Intrinsic YTW of 7.440%. Additionally, Moody’s is overstating SVU’s fundamental credit risk, viewing the firm as a highly speculative, high-yield B1 credit, four notches lower than Valens’ XO (Baa3) credit rating
Incentives Dictate Behavior™ analysis indicates that SVU’s management compensation framework is positive for credit holders as it aligns management to concentrate on drivers of Uniform ROA expansion, which should lead to higher cash flows available for servicing obligations going forward. Additionally, management members are not well compensated in a change-in-control, limiting event risk for creditors
SVU currently trades near historical lows, with a 0.9x UAFRS-based (Uniform) P/B. At these levels, the market is pricing in expectations for Uniform ROA to fall to 5%, with 2% Uniform Asset growth going forward. Given that valuations are likely being compressed by the market’s inaccurate perception of the firm’s credit risk, SVU could see material credit-driven equity upside if credit spreads tighten, even without fundamental improvement. Moreover, at current levels equity downside is likely limited, as asset values begin to offer a floor to valuations