Leveraged Finance House
Reading the market: In a truly dreadful year for leveraged finance, JP Morgan was able to deploy its global reach and transatlantic contacts to execute 2008’s biggest and most ambitious transactions. The bank’s strategic stance was able to feed sponsors’ deal appetite and bank investors’ desire for new, untainted LBO debt. JP Morgan is IFR’s Leveraged Finance House of the Year.
On the face of it, 2008 was a horrific year to be a bulge bracket leveraged finance house. As liquidity drained away from the global capital markets and leveraged buyouts became dependent on the bank bid, the size of possible transactions reduced dramatically.
“The elephant hunters had nothing left to shoot,” were the words of one senior banker from a mid market house.
But one bulge bracket bank was different. Without the vast inventory of unsold legacy deals from 2007 that hampered many of its rivals, JP Morgan was in a position to continue doing business throughout the year, and was able to benefit from what looks to be a return to old-fashioned, disciplined banking.
Indeed, on a global basis, JPM held onto its number one spot in the Thomson Reuters high-yield dollar-denominated league table for the 2008 awards period. The bank priced 47 deals for a market share of 18.4%. It also ranked second in the global leveraged loan league table with a market share of 11.3% from 348 issues.
“For the first time in a decade, liquidity is a strategic asset,” said Jim Casey, co-head of syndicated and leveraged finance at JPM. “Conversations regarding the sourcing of liquidity have gone from the treasurer’s office to the CEO’s and that has done wonders for JPM because we have relationships that enable us to have those dialogues fluently.”
Disciplined lending, selective partnerships and an ability to engage in ongoing dialogue were the mainstays of the market in 2008. This was a complete turnaround from recent years when even the most aggressive leveraged transaction was marketable and borrowers could hire almost any bank and still expect a successful syndication.
The shift in the market has played to JPM’s strengths, said Andy O’Brien, co-head of leveraged finance. “Capital was a commodity and money was cheap,” he said. “The market is now all about accessing the capital, getting deals done. And that played to our strengths, our brand, our structuring and our distribution.”
And in the key leveraged regions of the US and Europe, JPM was able to use its strength and experience to transact the year’s key deals – transactions that were impressive in terms of their size, innovation and breadth of syndication.
Dominating in the US
In the US, JPM dominated leveraged finance. It was one of the few prominent players in a year that saw a drastically reduced amount of issuance, as its rivals were forced to address the massive overhang of LBO debt, limiting the amount of new business they could book.
At the same time, deteriorating conditions and skyrocketing risk premiums also made the markets cost-prohibitive and difficult to access for many companies. As a result, those issuers who did come to market went directly to the best underwriters in the business.
“There was a fundamental shift in the way that issuers were evaluating underwriters and that played to our strength because we were already at the top of the heap,” said Casey.
Gone were the days of easy and abundant financings – in their place, issuers had become much more selective about how their deals would get done.
“As boards decided who should do their mission-critical financings, a lot of that business went to us by default because of our market share. But it also came to us because when we were making the pitch, we were describing how we were going to structure it, how we were going to price it, how we were going to deal with relative value, and, importantly, how it was going to trade in the secondary market – and we had a lot of credibility,” said Casey.
Those themes were evident early in 2008. Despite an extremely uncertain tone as the year began, JPM jumpstarted the market by pricing the first two bond deals of the year, transactions from Southwestern Energy and Atlas Energy. The bank also brought one of the first leveraged loans, a US$500m five-year credit facility for as Technitrol.
Conditions had not improved by March, when JPM left-led a successful drive-by transaction for Charter Communications, comprised of a US$520m six-and-a-half-year non-call four senior secured second-lien notes offering and a concurrent US$500m first-lien term loan B due 2014.
JPM, along with Credit Suisse and Deutsche Bank, raised the capital in one day in a very challenging market environment, proving that high quality deals could still get done at the right price. The deal also became the first dual market one-day execution ever priced in the high-yield and leveraged loan markets.
Both the term loan and the bonds priced in line with pre-launch expectations, with both tranches trading up.
Times were just as rocky in June when the bank left-led the financing to back B/E Aerospace’s US$1.05bn acquisition of a unit of Honeywell International. Due to high demand generated in the bond market, JPM increased the 10-year non-call five senior bonds by US$100m to US$600m, pricing them at par to yield 8.5%, in line with talk, while reducing the accompanying term loan. On the day of the bond pricing, the equity market lost 400 points, one of the steepest drops ever, but JPM held the book together.
Also in June, JPM left-led one of the most well received transactions of the year when Lender Processing Services tapped the bank to lead a US$1.725bn loan and bond offering to fund the company’s spin-off from Fidelity National Information Services.
The bank priced the US$375m senior note offering on the tight end of talk at par to yield 8.125%. The successful pricing and relative strength of the notes in the secondary market throughout the year amid deteriorating market conditions drew praise from a range of investors.
Other notable lead-left loan financings in the summer included a July loan and bond transaction for Ticketmaster, which saw JPM skilfully reworking the financing after initial reception proved only lukewarm in the very challenging market environment. The bank increased the credit facility by US$100m to US$650m and decreased the bond to US$300m, in addition to hiking the price of the offering to appeal to a broader range of investors. The coupon on the term loan B was upped from Libor plus 275bp to Libor plus 325bp, while pricing on the term loan A increased to Libor plus 275bp from Libor plus 250bp. The senior notes due 2016 priced at par to yield 10.75%.
Just a few weeks later JPM arranged a US$2.925bn loan to fund Manitowoc’s acquisition of Enodis. The deal, closed in August, comprised a US$400m five-year revolver, a US$900m five-year term loan A, a US$300m 18-month term loan X and a US$1.325bn term loan Y. The institutional tranches paid 350bp over Libor and were offered at 98 OID. The Ba2/BB+ ratings and decent spread appealed to a range of investors.
European focus
Over in Europe, Ray Doody, head of acquisition leverage finance, explained that success in 2008 required selectivity. “We rejected 70% to 75% of opportunities this year. We knew that for the right deal there was reasonable demand but at the same time we were conscious of the need to be disciplined and avoid anything that was either not distributable or too resource intensive.”
One sign of this discipline was how the bank chose to work with sponsors that had either a sector speciality or a track record with JPM. Typical here was how the firm underwrote on a sole basis a €730m financing to support the buyout of Foodvest, a European seafood and frozen foods business acquired by sector specialist Lion Capital.
The sole underwriting was a risky proposition given the volatility of the market. However, not only had the bank worked previously with both the vendor, Capvest, and Lion Capital, it was already a lender to Foodvest so giving it a good insight into the company. These were key factors in giving JPM the confidence to support the buyer rapidly with the certain financing needed to secure the buyout.
JPM was also a driving force behind the world’s biggest LBO of the year – Nordic Capital and Avista Capital’s buyout of healthcare business Convatec.
Here JPM was global coordinator on the US$2.75bn debt facility supporting the buyout. In helping to bring such a large debt package in a very difficult market, the bank was able to take comfort to a huge extent by the confidence that comes from sponsor Nordic Capital’s track record in the sector – including its ownership of Unomedical, a similar business that was ultimately rolled into the larger Convatec. In addition, the buyout hoped to draw upon the strong bank following that Nordic Capital enjoys in Europe.
Convatec, which is also IFR’s European Leveraged Loan of the Year, typifies the major trend in Europe this year: the co-ordinated deployment of capital exemplified by the club deal.
“Club deals are a necessity,” said Kristian Orssten, head of loan and high-yield capital markets at JPM in Europe. “But where you need a club to underwrite a transaction then you need to be involved with banks that you are confident will continue to be active in 2009.”
In 2008 clubs paid increased fees and tended to succeed where a bank took a leadership role in forming the group. This gave strong banks like JPM the change to stand out rather than be drawn along by an amorphous mass of banks.
“Partnering balance sheet with arranging and distribution skills can work well. That’s where we add value,” said Orssten.
The discipline to execute a club transaction effectively was to some extent a lesson learned from the debacle of the leveraged finance overhang, he added. “If we are in a club then we want to be the partner standing out with a leadership role. One of the lessons learned in 2007 was that dealing with a large bank group on a struggling deal can be a rock around your neck. Our experience highlighted the need to be defined as a lead bank, with a voice close to the issuer’s ear.”
Those concerns gave rise to the global co-ordinator role, which JPM fulfilled on the Convatec transaction, acting as the axis around which a far larger underwriting group could rotate to drive the deal forward.
Bookrunners and MLAs included not only JPM as global co-ordinator but also Bank of Ireland, Dresdner Kleinwort, UniCredit and GE, and MLAs HSH Nordbank, Mizuho Corporate Bank, Nordea, SEB Merchant Banking and Swedbank.
The ability to drive Convatec meant that despite its club structure the transaction featured the successful execution of a range of moving parts, notably a US$600m increase to the original US$2.175bn debt package, achieved at the same time as a 100bp flex down of the margin across a mezzanine tranche to 950bp over Libor.
To the future?
While JPM was active in supporting sponsors in Europe for deals like Foodvest, Convatec and Stabilus, its bankers are aware that 2009 is unlikely to see a large volume of buyout activity.
According to the bank’s European team, sponsors are now focused on their portfolio companies, with some 2006/2007 deals now having very little equity value left, meaning the sponsors have to play a very defensive game as equity holders.
New sponsor-driven primary deals are more likely to be generated out of restructuring opportunities or distressed investing than from traditional LBO auctions. They are also likely to be smaller and less easily banked.
Fortunately, JPM is already focused on leveraged corporate deals – such as the multi-billion transaction for Fresenius – as a source of dealflow, and a shift away from sponsor-driven primary deals would simply bring Europe more into line with the US, where the corporate leveraged segment already accounts for half of all deals, compared to 11% in Europe.
Doody sees a number of factors contributing to the trend. “In Europe, there has been a reluctance by corporate boards to issue non-investment grade debt, and a lot of corporates have been able to sell their debt at investment-grade terms and pricing by emphasising relationships to lender banks,” he said.
Such considerations no longer apply. And with corporate debt now pricing wider, bank investors who do remain committed to the leveraged finance space will be far more inclined to support corporate deals, which tend to feature lower leverage and have lower default rates than sponsor-backed deals.
In Europe, banks now dominate the debt market, taking 85% of any new deal, with institutional investors now minimal. But even in today’s tough market, for the right deal bankers say there is still demand. And with the secondary market still under pressure from unsold legacy deals and no sign of any new inflow of structured finance to support prices this situation is unlikely to change.
Being plugged in to the universe of bank investors has been crucial to JPM’s success in Europe. Successful execution of Convatec was entirely predicated on deploying global insight to shift the syndication focus for the deal from the US, where Convatec had been banked, to Europe, where JPM could quickly tap into bank appetite which was simply not available in the more institution-heavy US market.
Such insight and global range will remain crucial to the bank negotiating the market in 2009, where more uncertainty seems to be the only sure bet.
Joy Ferguson, Donal O’Donovan, Michelle Sierra Laffitte.