shifting tides: decoding the credit markets, structuring debt in volatile times

Shifting Tides: Decoding the Credit Markets, Structuring

Debt in Volatile Times

June, 2012

Sycamore Associates LLC


September, 2008: Try to Remember(“Hell is empty, and all the devils are here”…Shakespeare, The Tempest)

• Sunday September 14, 2008: Lehman files for bankruptcy protection AND Merrill Lynch is sold to Bank of America

• Monday September 15: Dow down 504, worst day in 7 years• September 16: AIG Liquidity Crisis, Fed takes 79% stake• September 19, Fed offers temporary increase to FDIC

insurance to prevent run on banks• Previously: Bear Stearns failure, Citi capital raising • Bank failures highest in 13 years• Regulators onsite at I-Banks• GM, Chrysler File for bankruptcy

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Bank Capitalization Issues and the Ripple Effect: Then• Capital Strains=Tight Credit• Higher Cost of Capital, for all Financials• New Ownership• Strategic Changes• Credit Scrutiny• Down grades “ as abundance of caution”• Changes in return disciplines• New regulatory environment• TARP implications


Current Events September 2009• Default rates: August 20,2009: Moody’s announces it believes default rates

will NOT go as high as previously predicted (15%). Moody’s cites the re-opening of the high yield bond market as a positive factor

• Bond Market trends: Capacity is still good• Does success in IGR really translate to other markets? High Yield Market

re-opens with $71B issuance YTD, a causative factor for the Moody’s prediction regarding defaults

• Private Placements: will investors go for a broader swath of credit profiles? Still to be seen

• We begin to see 3 year revolvers, • Amend and Extend• Some banks have repaid TARP funds• Regulatory issues remain hanging over the heads of banks, especially

those with TARP funds• Credit underwriting is still paramount, but

– We have heard our first comments from banks looking ahead to create earnings for 2010, if not 2009


Then the World Turned..2010 was a Very Good Year• Syndication loan market volumes rebound• Non-sponsored lending peaks in 4Q; recovers from 2009 lows

• Refinancings drive bulk of loan issuance; new money picks up in 4Q• Competition intensifies; terms continue to loosen

• Sponsored issuance logs second highest quarter, continues to gain market share

• Dividend recaps hit a new quarterly record• LBO lending increases

• Institutional issuance recovers from 2009 lows; still half of 2007’s peak levels

• Yields tighten to pre-crisis levels• Middle market premium narrows in December

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Flash Forward, Spring and Summer 2011Spring….• AT&T $20B bridge loan – underwriting

followed by immediate syndication success

Summer….• Express Scripts $14B bridge loan –

underwriting followed by successefull syndication but….European banks appetite limited

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Flash Forward, Spring and Summer 2011What next?• Euro debt concerns continue• Euro banks talk about liquidity• Banks are eager to lend, but…a more

cautious note has emerged• M&A catching fire?

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Ripped From the Headlines……

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Sycamore Associates LLC9

Back to the Future

confidential


Covenant levels in the investment grade market have loosened so far this year when compared to 2009, evidence that the market is easing back towards issuer friendly terms. Another sign highlighting this shift is that there are fewer covenants appearing in deals. For packages which included at least one financial covenant in 1Q-3Q10, 43% of deals for BBB rated borrowers contained only one covenant compared to 39% in 2009. Similarly, 49% of 1Q-3Q10 packages contained two covenants compared to 38% in 2009. On the higher end of the spectrum, covenant deals with 3 covenants decreased from 17% in 2009 to only 5% for 1Q-3Q10.

Covenant levels in the leveraged loan market have been loosening in 2010 compared to last year, a sign that lenders are willing to ease up on structure in order to stay competitive. For leveraged deals with an institutional tranche, the average maximum debt to EBITDA ratio was 4.97 times in 1-3Q10, much higher than 2009's average of 4.48 times, and even higher than 2008's 4.84 times. For pro rata credits, the average debt to EBITDA level has jumped to 4.5 times for 1-3Q10 compared to 3.81 times in 2009.

BBB rated borrowers see increase in market share of loans with one to two covenants

Debt to EBITDA cap loosens for leveraged issuers

Covenants and Structure: Investment Grade and LeveragedTrends – 1997 to 2010 (source: ThomsonReuters LPC)

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State of the Refinancing Wall

• Amend and extend has helped push maturities out


High Volatility Becomes a Trend

• Many well-managed companies are well-positioned with cash and low debt levels

• A more cautious tone prevails with a renewed focus on structure and ‘story specifcs’– LIBOR Floors: going, going…….back?– Half of deals in Q4 2010 had LIBOR floors– Only 11% had one in Q1 2011, BUT:– Update

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The Risk On, Risk Off Teeter Totter• Drivers

confidential


Biding Time – Safety at the Short End

confidential


Uncertainty Abounds: this train could stop• Geopolitical• Economic• Housing Market• UK economy struggles• Germany robust• Dollar woes• Debt, Debt, Debt• Return pressures

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Regulation Matters

• Regulation is the new driver at banks and other financial institutions.– Dodd Frank (US) – “proprietary trading”– Basel (global) – leverage ratio and liquidity

requirements will results in significantly higher capital over the next few years

– Jamie Dimon, CEO, JPMorgan: “Lending costs will increase, depending on the type of customer and the type of loan. It is possible that some companies may no longer go to banks for loans.” (September 2010)

– 2012: Peer to Peer lending emerges

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Regulation Abounds

• Basel III– Liquidity coverage ratio– Net stable funding ratio

• Dodd Frank and the Volcker Rule• Leveraged Loan Guidance (in the US)• Various other rules: FATCA


Regulation Matters to All of Us

• Higher capital and liquidity requirements will most likely mean more focused client relationship lending (and/or higher borrowing costs) as rules are implemented

• The playing field may not be level– Timing of implementation may vary globally– Some differences in local rules

• Systemically important financial institutions (SIFIs) face higher requirements


Impact of Regulation

• And what of the “shadow market”…

• We are living through a “case study” in credit, markets and regulation

• Peer-to-Peer lending: John Mack leads the way?

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– Overall – Slowing global growth and deepening Eurozone sovereign debt crisis– European banks facing funding constraints, changing strategies – Rising costs of funds across geographies

– Leveraged finance– Shorter, steeper cycles? Technicals swing between polar opposites: from overheating to

over-correcting– Aging CLOs are not being replaced proportionally – Challenges in underwriting with an evolving investor base

– Investment grade market – Variability in bank behavior – higher probability of surprises– Will market continue to digest bank pullback? How much pressure will this put on

capacity? – Basel III and changes to internal models which dictate pricing must go up coupled with

shorter tenors; Unfunded RCs will become prohibitively expensive

Source: Thomson Reuters LPC Quarterly Survey

Aggregated survey responses across themes

Conclusion: What are the biggest issues/changes facing the loan market?


Appropriate Markets? Who Invests?• Senior debt:

Unsecured• Public Debt• High-yield and

Secured Debt• Asset based• Mezzanine• Equity or equity-

linked

• Banks, Insurance Companies

• Funds, Insurance• Hedge funds,

Insurance Co., some banks

• Banks and finance Co.

• Funds and PE• Public and PE

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Europe vs. US vs. ASEAN

• Markets Linked but not Lockstep

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Update on negotiating changes

• Boilerplate changes• LIBOR floors, etc• fees

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Market Today

• Trends and outlook– Global market– Investment grade– Leveraged

• Overview of Pricing• Regulatory developments• Future themes for the loan market

Sycamore Associates LLC Source: Thomson Reuters LPC

Global syndicated lending dropped 30% to $646 billion in 1Q12

0

200

400

600

800

1,000

1,200

1,400

1Q04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

Americas EMEA Asia-Pacific (ex Japan) Japan

Issu

ance

($B

ils.)

Global syndicated loan volume

4

Sycamore Associates LLC Source: Thomson Reuters LPC

Change in issuance year over year

Year-over-year, lending in EMEA shows biggest drop

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In the US…1Q12 leveraged lending was up 42%; investment grade was down 54% vs. 4Q11

Issu

ance

($B

ils.)

Source: Thomson Reuters LPC

U.S. Loan Issuance


Source: Thomson Reuters LPC; TR LPC’s Quarterly Survey

U.S. IG New money vs. refis Quarterly survey results

22% of lenders struggle with capital constraints

• Capital constraints? • 22% of investment grade lenders are more

constrained this year with regard to total availability of capital

• 11% are less constrained• 67% have the same amount of capital

• Outlook for the refinancings pipeline this year?• 11% say anemic• 67% say slow but steady• 22% say robust

• Will the make-up of bank groups change in 2Q?• 42% say yes• 29% say maybe• 29% say no


Higher quality issuers continue to utilize MBP


Volume of IG loans structured with Market Based Pricing


Longer tenors continue to dominate structures

364 day 3 year 5 yearSource: Thomson Reuters LPC

Tenor distribution by rating

0

25

50

75

100

125

150

175

200

2Q11

3Q11

4Q11

1Q12

2Q11

3Q11

4Q11

1Q12

2Q11

3Q11

4Q11

1Q12

2Q11

3Q11

4Q11

1Q12

($ B

ils.)

AAA AA A BBB

4 year


1Q12 High yield bond issuance reached $91 billion, breaking 4Q10’s $83 billion record

Source: Thomson Reuters, Thomson Reuters LPC

Annual & quarterly institutional loan and HY bond volume


$32 billion in HY bonds were used to pay down loans in 1Q12; select issuers pursued A&Es


A&E Volume 30% of HY bond proceeds were used to pay down loans in 1Q12


Refi activity drove leveraged lending in 1Q12


Leveraged lending Institutional loan issuance only


US Market Indicative Investment Grade Pricing

*spread over Libor


US Market Indicative Leveraged Loan Pricing


US Market Indicative Mid-Corporate Loan Pricing


Structure Guidelines and Pitfalls• Know your own credit profile • Research similar deals• Survey your bank group• Ask what risk rating your company has

internally• Ask banks to share their return dynamics

with you

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Middle Market Fares Not As Well• Ugly Stepsister? • Less flexibility in covenants• Less pricing reduction• Still credit-profile driven• Update

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Covenants: The High-Grade vs. Mid Market Divide• More covenants in MM• Lower leverage thresholds• Higher coverage levels• Based on generally more conservative

underwriting standards• Reflects recent experience of downturn,

lower capitalization, reduced access to capital markets

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Pricing

• Dependent on many factors, including sponsorship, asset support, but

• Generally can negotiate less: • E.g. reduced guaranties, foreign

subsidiary requirements• Baskets for acquisition and investments

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But What’s to Come?

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True is it that we have seen better days."- William Shakespeare, As You Like It, 2.7


What Does the Future Hold?

• There are some clouds on the horizon…– Impact of sovereign risk

• Funding costs are higher for many institutions– Basel III capital regulations have stringent capital

AND liquidity requirements for financial institutions• Phase in delayed for several years

– CRE still a huge issue among smaller regional financial institutions

– Investor appetites

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Q and A

• Sycamore Associates• Risk, Capital Structure and Treasury Solutions• Winifred Pinet,

[email protected]• Marcia Banks,

[email protected]• Gina Strumolo,

[email protected]• Newsletter, [email protected]

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mailto:[email protected]

mailto:[email protected]

shifting tides: decoding the credit markets, structuring debt in volatile times

Documents

b bridge loan underwriting

high yield bond market

extendsome banks

heads of banks

high yield market reopens

market sharedividend

b issuance ytd

issuance logs