Superficially it appears that little changed in the North American investment-grade loan market this year. Spreads continue to tighten, covenant protection is eroding and refinancings abound. But below that veneer it is clear that the fall in pricing has slowed and that there are fewer covenants to take out or soften. This recognition of what may be the best market yet for borrowers has spurred several jumbo refinancings and welcomed first-time borrowers to the market. Timothy Sifert reports.
Investment-grade corporations have completed US$706.1bn in loan volume for year to September 19, according to data from Thomson Financial. That’s a roughly 11% larger market than last year when borrowers recorded US$636.2bn in volume for the same period, and 22% larger than the loan market in 2004 when volumes reached US$578bn.
A variety of factors has driven this escalation in volumes this year. Time Warner led the year with its outsized US$21bn refinancing, while issuers such as Tribune tapped the market to buoy sinking stock prices through buybacks. On top of that, more technology companies that ever found their way the high-grade market, owing to market specific developments. Whatever their specific reason, however, most borrowers came to market because the conditions were – and still are – ideal to lock in long-term debt.
“For most of 2006 we've been advising companies that we are nearing peak conditions in the loan market, and that it's an opportune time to modify their credit facilities,” said Dennis Dee, managing director and head of corporate loan markets at RBS. “There are numerous examples of companies doing this. Some are extending tenors while also reducing pricing and/or exercising accordion features. They are taking action at a time of perceived optimal market conditions.” He explained that companies were even atypically returning to market just a year after completing a multi-year facility in order to extend tenors, reduce pricing or exercise accordions.
Bank of America and Wells Fargo, for instance, were in the market in September to exercise an accordion feature for Harrah’s Entertainment. The deal aimed to increase the casino operator’s US$4bn revolver to US$5bn. Other borrowers have returned for similar increases, as conditions allow.
The peak borrowing conditions now could point to a slight market downturn soon to come, some say. The Federal Reserve appears to be done raising rates, for example, and borrowers are beginning to think about the impact this will have on liquidity. Similarly, the auto and housing sectors show conspicuous signs of slowing. Separately, the impact has been minimal, but together it could be indicative of a weakening economy. Borrowers that anticipate this are adjusting their loan agreements accordingly.
Time Warner and Time Warner Cable completed a US$21bn four-tranche loan in February, which signalled the start of an active year. In addition to being one of the larger investment-grade deals, Time Warner’s transaction also spread its wealth in a high-grade market where volumes are heavily concentrated among three banks: JPMorgan, Bank of America and Citigroup. Citigroup and BNP Paribas led a US$7bn five-year credit facility for Time Warner. Meanwhile, Time Warner Cable completed three other tranches: a US$6bn five-year revolver, via Bank of America and Deutsche Bank; a US$4bn three-year term loan, through Wachovia and Barclays; and a US$4bn five-year term. loan through Bank of Tokyo-Mitsubishi and RBS. The deal financed Time Warner's circa US$18bn acquisition of Adelphia Communications with Comcast, as well as a share repurchase.
Nor was Time Warner alone in using loans to finance a share buyback. One of the reasons leveraged buyout activity has been so intense of late is because there have been several under-levered companies with under-valued stock prices. Private equity funds have been keen on loading up the balance sheets of these investment-grade companies to buy their undervalued equity, thus relegating their credit ratings to junk. Freescale Semiconductor, for example, agreed to be bought out by a Blackstone Group-led consortium. Its ratings have since suffered as a result.
To ward off LBOs, and to prop up stock prices, companies have been launching share buyback programs and financing them in the loan market. Newspaper publisher Tribune launched a US$2.25bn loan in June to help finance its planned buyback of as many as 75m shares and refinance debt. It was just barely able to hang on to its investment-grade rating because of the deal. Moody’s eventually lowered its ratings in the course of events to Ba1 from Baa1 before the announcement of its plans. S&P lowered its rating from A- to BBB-.
Tech companies emerge
Technology companies, in particular, have become more active in borrowing. This is the result of a confluence of sector-specific trends. Once defined as high-growth, high-volatility companies, many technology companies have since matured and stabilised their businesses.
This shift has, among other things, left these corporations with huge cash piles. And shareholders have taken note. They have complained that companies are holding onto too much cash, and that they should either use it or give it back to the investors who would do better to invest it elsewhere. Microsoft, for example, used some of its cash pile of US$34.2bn in August to buy back US$3.8bn of its stock. Thus there have been cash-funded share buybacks and dividends.
Now that some of these tech companies have less cash, revolvers have been necessary in lieu of their wealthy coffers. “It’s absolutely a trend and it’s become more so this year,” a loan banker said. “Using cash on hand and equity for purchases is fine for rapidly growing companies. But a lot of tech companies are not growing as rapidly and they realise that it’s time for ‘big boy’ balance sheets. And shareholders are pushing these companies to give back their cash.” As such, loan issuance by technology companies has increased this year compared to the previous two (see chart 2).
“Shareholders are saying that we want to deploy the cash somewhere else,” the banker said. “And once they satisfy their shareholders, they need liquidity for a rainy day. This is where they talk to us about credit facilities or, in other cases, bonds.”
Symantec completed its first fully syndicated loan in July. JPMorgan, Citigroup, Bank of America, Morgan Stanley and UBS arranged the US$1bn five-year senior unsecured revolver for the California-based IT security company. A banker involved in the transaction said that Symantec formerly borrowed from the bank market through bilateral arrangements, which has been a borrowing method used by many tech companies that avoids wide syndication.
Symantec's transaction, like other deals in the sector, was not rated by agencies. But banks and lenders rated the company internally as investment grade. This is evidenced by Symantec’s ability to achieve investment-grade spreads. The deal pays 27bp over Libor, a utilisation fee of 10bp and a facility fee of 8bp. Proceeds are for general corporate purposes.
Cisco Systems has also taken the plunge into the high-grade debt market. The computer company completed a US$5.5bn credit facility in February. Citigroup was administration agent. JPMorgan and Morgan Stanley were syndication agent and managing agent, respectively. Bank of America also recently completed a US$500m five-year unsecured revolver for VeriSign. The company is also unrated, but the deal is structured like an investment-grade facility. It pays 50bp to 102.5bp over Libor, based on its leverage ratio.
The volume of investment-grade technology deals has more than doubled since last year. So far this year technology companies have completed US$42.9bn in volume compared to US$20.7bn last year. That figure is expected to continue to grow rapidly, bankers said.
Agreeing on covenants
The gradual decrease in pricing has often lured borrowers back to the market across a variety of sectors. But as the spread tightening has slackened lately, borrowers are also seeking new transactions with fewer covenants. That means that lenders will have fewer warning signals before a company gets into credit trouble.
"In investment-grade loans, the whole issue of covenants has been a big focus," said Bill May, senior director, credit market research at Fitch Ratings. "Clearly, changes in covenant packages have been more prominent in leveraged loans, but we see it in investment grade, too. In a recent study, about 50% of the rated investment grade loans we looked at carried interest coverage covenants in 2005, compared to about 34% so far this year. That's near its lowest level in the past 10 years.” All of this provides lenders with less covenant protection.
Not only are their fewer covenants, but there ones there are have slackened. “Simultaneously, along with a decline in the occurrence of a debt-to-cash flow leverage covenant, there has been a modest increase in the average level of leverage allowed in these leverage covenants," May said.
In addition, there has been an increase in the percentage of Triple-B rated companies in the investment-grade market. This translates into an aggressive ratings mix with a decline in coverage protection. “These are not trivial developments,” he said.
However, as few would dispute, May said that the market was still as robust as ever. “That doesn’t seem to have let up.”