Why is Four Seasons Health Care, the country’s largest care homes operator, in financial difficulty? Why is the regulator, the Care Quality Commission, having to prod and cajole creditors to agree a standstill on debt repayments to prevent the business falling into administration? Why is this crisis happening only six years after the failure of Southern Cross, which at the time was the biggest company in the industry?
One could point to forces that are well-known. Fees are under pressure because local authorities’ social care budgets have been squeezed; overheads have been forced up by increases in the national minimum wage; and, at the margin, Brexit complicates staffing requirements.
Those factors are real but let’s not lose sight of the ingredient at the centre of the Four Seasons affair. It’s debt – too much of it. Terra Firma, Guy Hands’ private equity firm, over-paid for the business in 2012 and loaded up with leverage. At heart, this is an old-fashioned tale of financial engineering gone wrong. Southern Cross came from the same unlovely stable – in that case, the financial error was addiction to fancy sale-and-leaseback property deals.
Terra Firma would be correct to plead that its debt structure was more conservative than those imposed on Four Seasons by previous owners, notably the Royal Bank of Scotland. But it’s not much of a boast.
Hands’ crew paid £825m for Four Seasons, of which about £500m was borrowed money. Look at the punishing interest payments it had to agree to find takers for the debt. There are £175m-worth of junior unsecured notes today that carry a coupon of 12.25%, and the £350m-worth of senior notes pledge to pay the bearer interest at 8.25% a year. Bond investors spotted at the outset that this was a high-risk deal in a sector with a history of financial accidents.
What was Hands thinking? He thought Four Seasons was in his investment “sweet spot”, he wrote in a letter in 2014 to the Economist, which had accused him of being in too much of a hurry after his big flop with music publisher EMI. Four Seasons, said Hands, was “asset-backed, in an essential industry and in need of fundamental change”.
Well, it was asset-backed only up to a point: 185 out of 343 homes are leasehold properties. But those other long-term virtues could only shine if the debt structure allowed room to manage through the lean years. Four Seasons’ slow march towards crisis has been flagged for months – indeed, the first mini-crisis came at the end of 2014.
To his credit, Hands tried to keep the financial show on the road with two extra £50m injections of capital. And, as far as one can tell, he has honoured his promises to invest in the business. In the end, though, Four Seasons has arrived at a point where it is struggling to meet a £26m debt interest payment due on Friday. H/2 Capital Partners, the US hedge fund that has bought up majority positions in both classes of debt, holds the aces. It will probably clean up at the expense of Terra Firma since, with a gentler debt structure, Four Seasons is a good business.
H/2 should still do the decent thing and get the financial restructuring underway as soon as possible. There is no need for an administration that could cause problems for the regulator and local authorities. Get on with it.
The rest of us, though, can only look at the current standoff and shake our heads. The UK is awash with long-term pension fund money that would happily build and own care homes for modest real returns. Instead, we have a high-stakes financial game in which players aim for fatter rewards.
The result, in this case, is that control of the biggest care homes operator in the land will probably pass from a private equity outfit that made a rotten bet on financial leverage to an opportunistic US hedge fund that hunts for junk bonds to buy at a discount. It’s a shocking way to fund provision of care homes for the elderly.
What happened to the old bank?
It’s a triumph – sort of. HSBC has avoided the threat of prosecution from US authorities over the great Mexican and Colombian money-laundering scandal that was exposed half a decade ago. The US Department of Justice monitor who has been embedded in the bank since 2013 has deemed HSBC to be much improved.
In truth, something would have gone seriously wrong if HSBC hadn’t received a bill of health. The bank has thrown money and thousands of staff at overhauling compliance systems. Stuart Gulliver, soon to depart as chief executive, has also extracted the bank from “high-risk” countries such as Colombia, Peru, Uruguay, Paraguay, Costa Rica, El Salvador and Honduras.
Those clean-up actions were a correct response to the crisis. But, amid their relief at the DoJ’s move, HSBC investors will think of what might have been. A quarter of a century ago, this was the conservative bank that kept its nose clean.
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