positioning for growth: refinancing your business and accessing capital private company webcast...
TRANSCRIPT
Positioning for Growth: Refinancing your business and accessing capital
Private Company Webcast Series: Part 2 of 4
30 April 2013
Credit market updatePage 2April 2013
Welcome
Steve Lewis Brian Allard
Meet the presenters
Credit market updatePage 3April 2013
Agenda
► Current market conditions
► Types of financing
► Risk mitigation strategies
► Conclusion
► Selected Ernst & Young Orenda transactions
Credit market updatePage 4April 2013
Current market conditions
Credit market updatePage 5April 2013
Credit markets – global viewpoint
► The heightened uncertainty around the global economic outlook has decreased
► Tentative signs of stabilization in European bank funding and sovereign debt markets had improved conditions in global financial markets and resulted in a reduction of risk aversion, however, we are still in a vortex of uncertainty
► In the US, expansion is proceeding at a modest pace supported by a falling unemployment rate, improving credit markets and stronger consumer confidence
► Supported by this more positive outlook and an injection of liquidity from central banks, global equity prices have rallied and corporate and government bond spreads have narrowed
Credit market updatePage 6April 2013
Interest rate environment
► This moderate recovery is fuelled by interest rates which continue to be at historic lows
► Since May 2011, Government of Canada yields have decreased by 139 bps for 10-year bonds and 114 bps for 30-year bonds on flight to quality flows primarily resulting from the Eurozone debt crisis
May/0
8
Aug/0
8
Nov/0
8
Feb/0
9
May/0
9
Aug/0
9
Nov/0
9
Feb/1
0
May/1
0
Aug/1
0
Nov/1
0
Feb/1
1
May/1
1
Aug/1
1
Nov/1
1
Feb/1
2
May/1
2
Aug/1
2
Nov/1
2
Feb/1
3
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50 Canadian Interest Rates [%]
GOC 5Yr GOC 10Yr GOC 30Yr
Credit market updatePage 7April 2013
Interest rate forecast
► Despite this favourable interest rate environment, however, the consensus outlook is that the yield on 10-year and 30-year Government of Canada bonds will increase by up to 44 bps and 38 bps, respectively, by December 2013
► The interest rate outlook from the major Canadian banks is presented below
Source: BMO Capital Markets, CIBC World Markets, RBC Economics Research, Scotia Capital, TD Economics
2-yr 5-yr 10-yr 30-yr0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%Interest Rate Forecast - Q4 2013 [%]
CIBC (March 4, 2013)
Scotia (March 27, 2013)
RBC (March 2013)
TD (March 19, 2013)
Average
Credit market updatePage 8April 2013
Corporate credit spreads
► The graph below illustrates the spread between 3-month BAs and 3-month Canada Treasury Bills
► Spreads have narrowed significantly since the days of the credit crunch, and continue to decline following a slight increase throughout 2011 reflecting uncertainty around the global economy and concerns over the Eurozone
Source: Bank of Canada
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 200.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
1.60%3-Month BAs over 3-Month Canadian Treasuries
3 Month BAs 3 Month Canadian Treasuries Spread
Ra
te
Sp
rea
d
2013-04
Credit market updatePage 9April 2013
Debt Multiples
► Debt multiples in the first quarter of 2013 are significantly higher from the first quarter of 2012
► On an annual basis, average debt multiples of middle market loans have been on the rise illustrating the availability of financing in the market
Source: S&P Capital IQ Leverage Commentary & Data
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
1Q12
1Q13
0.0x
2.0x
4.0x
6.0x
4.84.6
4.14.0
3.63.8 3.9
4.14.3 4.4
4.8
4.3
3.43.7
4.2 4.3
3.8
5.1
Average Debt Multiples of Middle Market Loans
FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDASeries5
Credit market updatePage 10April 2013
Types of financing
Credit market updatePage 11April 2013
Cost of capital
► The cost of capital varies based on the type of capital
Senior DebtTraditional
Asset Based Loans
Second LienLoans
Subordinated
Debt
Equity
Pre-Tax Cost of Capital
3% - 5%Coupon only
25%+
3% - 5%Coupon only
8% - 12%Coupon only
14% - 18%Coupon and warrants
Credit market updatePage 12April 2013
Senior debt Cash flow loans
► Larger cashflow loans to borrowers of “strategic relevance” to lenders► Senior leverage < 3.5x although recent activity has been
pushing this higher
► Industry specific
► Sponsor makes deal “easier”
► Spreads in the range of 100 bps
► Smaller cashflow loans must fit in the “credit box” of lenders► Positive track record
► Balance sheet covenants
Credit market updatePage 13April 2013
Senior debt Asset based loans
► Asset based loans (“ABLs”) are becoming increasingly attractive to certain borrowers► Loans > $60MM pose a syndication risk
► Spreads in the range of 175 – 350 bps over bankers acceptances
► Asset based loans are also attractive to lenders due to tightly structured borrowing bases developed during scheduled asset appraisals and field exams
► ABLs provide:► 3 Year committed financing
► Higher debt levels as the amount of financing is directly tied to the underlying working capital collateral balances
► Reduced covenants typically at less restrictive thresholds (i.e. tangible net worth or fixed charge coverage)
► Asset based financing is also well suited to finance growth as funding will rise and fall with the success of a company’s growth program
Credit market updatePage 14April 2013
Senior debt Asset based loans
► The key issues around ABLs are:► Significant reporting requirements
► More cumbersome documentation
► Requirement for appraisals and field audits
Credit market updatePage 15April 2013
Second lien loans
► Second lien loans are considered a cheaper and more flexible alternative to mezzanine financing for the mid to upper-middle market
► For the middle market, second lien loans combined with senior debt are an alternative to high yield bonds
► Second lien issuance plummeted sharply after the credit crunch and although it appears to be reviving, today’s market remains far from the excesses of 2006/2007► In general, the market for this paper is hedge funds, high-yield funds and other
relative-value players
Source: S&P Capital IQ Leverage Commentary & Data
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1Q12 1Q130
5
10
15
20
25
30
35Second Lien Volume (US $billions)
Credit market updatePage 16April 2013
Mezzanine financing
► As an alternative to equity, mezzanine financing can be attractive for a number of reasons:► Greater certainty of close with approvals from fewer parties required
► More simplified documentation if warrants are not required
► Stable source of financing due to a longer-term investment horizon (committed to a 4 or 5 year term)
► Mezzanine loan characteristics can include the following:► Total leverage ≥ 4.00x although on occasion recent activity has
pushed this higher
► Inter-creditor agreement with senior lender(s)
► Subordinated security position
► Warrants could be necessary to provide the required return
Credit market updatePage 17April 2013
Senior Loan Officer Survey, Bank of Canada
*The balance of opinion is calculated as the weighted percentage of surveyed financial institutions reporting tightened credit conditions minus the weighted percentage reporting eased credit conditions.Source: Senior Loan Officer Survey, Bank of Canada
► Survey results point to an overall easing of business-lending conditions in the first quarter of 2013
► Respondents consider competition among lenders as the key factor underlying the easing in business-lending conditions
2001
:Q1
2001
:Q3
2002
:Q1
2002
:Q3
2003
:Q1
2003
:Q3
2004
:Q1
2004
:Q3
2005
:Q1
2005
:Q3
2006
:Q1
2006
:Q3
2007
:Q1
2007
:Q3
2008
:Q1
2008
:Q3
2009
:Q1
2009
:Q3
2010
:Q1
2010
:Q3
2011
:Q1
2011
:Q3
2012
:Q1
2012
:Q3
2013
:Q1
-60
-40
-20
0
20
40
60
80
100Senior Loan Officer Survey: Overall lending conditions
EasingEasing
Tightening
Credit market updatePage 18April 2013
Easing credit standards
► The Federal Reserve Board conducted an opinion survey in April 2012 of senior loan officers asking participants to rank the possible reasons for easing credit standards or loan terms
Reasons for easing credit standards or loan terms
% Viewed as Very
Important
% Viewed as Somewhat Important
Improvement in your bank’s current or expected capital position
2.9% 2.9%
More favourable or less uncertain economic outlook 2.9% 40.0%
Improvement in industry specific problems 5.7% 8.6%
More aggressive competition from other banks or nonbank lenders (other financial intermediaries or the capital markets)
51.4% 45.7%
Credit market updatePage 19April 2013
Recent deals / Examples
Situation:
► 2 shareholders own a company with $2MM EBITDA before bonuses, and negligible shareholders’ equity.
► Company is a distributor with a seasonal working capital build-up.
► Bank would not allow payment of $1MM shareholder loans and demanded the shareholders inject $3MM into the company.
Solution:
► Company had sufficient accounts receivable and inventory to support a larger line of credit without leverage covenants.
► Negotiations with lenders enabled a solution which allowed repayment of shareholder loans, payment of bonuses and no requirement for an equity investment by shareholders.
Credit market updatePage 20April 2013
Recent deals / Examples
Situation:
► Mining services company with $40MM EBITDA, $100MM of shareholders’ equity and $40MM loan facility.
► Company’s operations were about 50% outside of Canada/US and all significant growth opportunities were outside of North America.
► Company required further capital for growth and to repay $20MM shareholder loan.
► Existing bank was willing to provide incremental capital in form of subordinated debt.
Solution:
► Company had total cash float of about $15MM around the world.
► Arranged $80MM senior debt facility allocated to global operations with new global cash management system.
► More efficient cash use, substantially cheaper than subordinated debt, shareholder loan repaid and company continues to grow.
Credit market updatePage 21April 2013
Risk mitigation strategies
Credit market updatePage 22April 2013
“Companies are taking the view that they need to negotiate the financing when it’s available, not
necessarily when they need it.
There’s an old investment banking adage, ‘If the duck is quacking, you feed it.’ In other words, if you
can get the financing done, get it done…”
Credit market updatePage 23April 2013
Financing risks
Availability / Liquidity
Risk that availability/liquidity in capital markets will be constrained
Credit Spread
Risk that credit spreads will increase
Interest Rate
Risk that interest rates will increase
Credit market updatePage 24April 2013
Financing risk mitigation strategies
Availability / Liquidity
► Issue debt in advance of capital needs
► Negotiate committed bank financing
► Maximize the commitment period or term of the financing
Interest Rate
► Issue debt in advance of capital needs
► Interest rate swap with forward start date
► Bond forward for fixed rate debentures
Credit Spread
► Issue debt in advance of capital needs
► Maximize the commitment period or term of the financing
► Interest rate swap with forward start date
Credit market updatePage 25April 2013
Alternatives to mitigate risk
Bond/Private
Placement
► Private placement is a direct placement of debt with one or two investors (narrowly marketed)
► Typically investment teams at Canadian life insurance companies and smaller pension funds
► Can also have a “public-style” or broadly marketed private placement, however need a minimum amount to access this market
Credit market updatePage 26April 2013
Alternatives to mitigate risk
Fixed Rate Bank Loan
► Bank provided fixed rate loan typically priced as “all-in” interest rate: bank cost of funds + credit spread for risk
► Commitment terms vary
► Currently 5 to 10 year tenures available. Up to 15 years for investment grade borrowers
Credit market updatePage 27April 2013
Alternatives to mitigate risk
Interest Rate Swap
► Contract between a borrower and a counterparty (i.e. a bank)
► Two parties in swap contract exchange fixed rate interest rate payments for floating interest rate payments
► Highly flexible; customized draw downs, interest-only periods, multiple rates, forward starting rates and terms up to 30 years
Credit market updatePage 28April 2013
Mechanics of an interest rate swap
► Borrower obtains bank financing by entering into a loan agreement with lender where interest is priced on a floating rate basis, i.e. 3-month Bankers’ Acceptances (BAs)
► Swap is a contract between a borrower and counterparty and is independent of the underlying loan or credit facility
► ISDA Master Agreement and Schedule govern swaps
► Swaps can either be spot or forward starting where borrower fixes interest rate for a future draw(s)
Swap Counterparty(Typically Securities Division of Lender)
Borrower Lender
Swap rate
3-month BA
3-month BA + credit spread
Credit market updatePage 29April 2013
Swap rates
► Swap rates declined in 2011 to historically low levels, driven by the reduction in the yield of underlying Government of Canada bonds
► The decline is a global trend driven by reduced prospects for economic growth due to weakening US and European economies
Jan/1
0
Apr/1
0
Jul/1
0
Oct/1
0
Jan/1
1
Apr/1
1
Jul/1
1
Oct/1
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Jan/1
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Apr/1
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Jul/1
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Oct/1
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Jan/1
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Apr/1
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0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%Canadian Swap Rate
10 yr 5 yr
Credit market updatePage 30April 2013
Swap rates
► Flat swap curve
► Benefit is obtaining upfront committed capital without negative interest carry; simply pay standby fees on undrawn balance
3M
6M
9M
1Y
2Y
3Y
4Y
5Y
6Y
7Y
10Y
12Y
15Y
20Y
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00% Canadian Swap Curve
Credit market updatePage 31April 2013
Pros and cons of interest rate swaps
Interest rate swap considerations
Advantages Disadvantages
► Committed future financing with certainty of cost
► Greater degree of predictability in cash flows
► Interest rate and credit spread risk can be mitigated for the term of the commitment
► Prepayment prior to maturity may be subject to a cash settlement (however, could receive a cash payment if the mark-to-market value is positive)
Credit market updatePage 32April 2013
Conclusion
Credit market updatePage 33April 2013
ConclusionLessons learned
► Markets are volatile. Mitigate risk. If you can access, or lock down credit, do it
► If appropriate, include multiple banks in your syndicate► Manage your lender relationships – avoid surprises► If in doubt, seek alternative proposals – you may be better
than you think► Optimizing capital extends beyond funding alternatives –
the “Capital Agenda”
Credit market updatePage 34April 2013
Selected Ernst & Young Orenda transactions
Credit market updatePage 35April 2013
Selected transactions
* Transaction services provided by a predecessor firm
Credit market updatePage 36April 2013
Selected transactions
* Transaction services provided by a predecessor firm
Credit market updatePage 37April 2013
Selected transactions
* Transaction services provided by a predecessor firm
Credit market updatePage 38April 2013
Selected transactions
* Transaction services provided by a predecessor firm
Credit market updatePage 39April 2013
Questions?
Steve Lewis, Senior Vice President
T: 416.943.2659E: [email protected]
Brian Allard, Senior Vice President
T: 416.943.2665E: [email protected]