Investor Demand for Cash Flow Deals

Every day, I talk with institutional investors about deals.  Institutional investors have capital which they need to invest. So, what do I hear from these investors?  What are they looking for?

Today, many tell me they want predictable quarterly cash returns.

Some want fixed payments, something in a debt instrument.

Many, however, will accept some variability in the payments. they’ll take some equity risk, to get a better return.

I’m seeing a large and growing universe of these investors.

If you can offer investors a generally predictable cash return, you can get investment capital.

Naturally, institutional investors will ask what could go wrong to diminish their cash return. The better your answer, the stronger the investor demand and the lower your required payments.

Also, if your investment has underlying assets, like real estate or equipment that can be sold to raise capital in a pinch, this also makes your investment more attractive.

So, if you’re raising capital for an investment that generates strong cash flows, consider using those cash flows to pay investors a periodic cash return. 

I recognize that if you pay out the cash flow to investors which you need to reinvest for growth, you’ll have to raise more capital.

The good news is that if you’ve gained a track record for paying investors their periodic cash return as promised, you’ll have no trouble raising capital at attractive terms.

Please contact me to discuss your capital market goals. Thank you.

Dennis McCarthy

Dennis McCarthy

Unintended Consequences for Bond Market Liquidity

Regulatory changes under the Dodd-Frank Act designed to reduce the risk of another financial market downturn may have the reverse effect so suggests an article in “FierceCFO”, the online magazine.

My takeaway from the article is that new regulations forcing large banks out of proprietary bond trading and concentrating it in the hands of hedge funds will increase the risk of illiquidity in the event of another period of instability.

The article suggests that in the event of another period of economic uncertainty, hedge funds will quickly step away from the market accelerating illiquidity.  Regulators have much less leverage over hedge funds to maintain some level of liquidity than they have over the banks.

Click here to read the article on “FierceCFO”.

“FierceCFO” article summary

Liquidity: How regulators are fueling the next crash

We’re not fans of deregulation, but the opposite does have unintended consequences. And TABB Group just released a report that suggests the changes brought about by Dodd-Frank and other regulatory moves made in response to the last financial crisis may set the stage for the next one. How so? By shifting bond trading from banks to hedge funds, which have more freedom to pull in their horns just when the market needs the opposite. In other words, liquidity could dry up at just the wrong time. The money quote comes from Colin Teichholtz, co-head of fixed income trading at Pine River Capital Management: “These new liquidity providers can just turn off the machine in bad times,” Teichholtz said. “Illiquidity can beget illiquidity and there is no obligation on these players to make market. The danger is that the dealers won’t be around to pick up the slack. The optimum business model won’t be to warehouse risk.”

In an interesting development on this topic, Liquidnet, an equity trading “dark pool” is expanding into bond trading to provide an additional trading venue for the bond market.  As the article above stresses, the trading activity conducted by hedge funds through “dark pools” can dry up at any time if parties step to the sidelines.

Click here to read the article on FierceFinanceIT about Liquidnet entering bond trading.

 

European High Yield Bond Spreads Return to Lows

SpreadsChart

 If your company qualifies for raising high yield debt, the European market may be a receptive market.

The spreads on European high yield debt are approaching the lows seen before the financial turmoil in 2008.

This may prompt European companies which had pursued a conservative strategy over the last 5 years to become more expansive with the availability of lower cost capital.

Similarly, low cost capital may spark an increase in acquisitions by both companies and private equity groups.

Click here to go to the website of the Federal Reserve Bank of St. Louis for background on the BofA Merrill Lynch data.

Covenant-lite Loan Volume Doubles

By Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com –

If your company hasn’t already refinanced into a covenant-lite loan, you should consider refinancing now.  

Not all borrowers will qualify for a covenant-lite loan but, if you can obtain one, a covenant-lite loan is typically easier for a borrower. 

A borrower with a covenant-lite loan will likely spend less time managing to loan covenants and certainly less money on obtaining waivers of covenant terms.

Recently,  Standard & Poor’s reported that the volume of covenant-lite loans so far this year (through Aug 8th) is double that of all of last year.

So far in 2013, more than half the leveraged loans to come to market have been covenant-lite vs. roughly 22% of loans to this point in 2012.

In addition, S&P reports that even smaller loan sizes, $200 million and under, are getting covenant-lite treatment.

Covenant-lite does not mean covenant free. 

Covenant-lite generally means that the loan does not have maintenance covenants, such as a minimum ratio of cash flow to interest, known as an interest coverage test. 

If your company has a loan outstanding, it probably has several of these maintenance covenants set as a relatively tight “trip wire” to alert your lender at the first sign that your company’s results are diverging from its projections.

While covenant-lite loans don’t have maintenance covenants, they often have other types such as negative covenants and incurrence tests. For example, a negative covenant might limit the amount of dividends that a company could pay to its equity or an incurrence test might limit the amount of debt a company could take on.

These covenants restrict a company’s actions but leave a company plenty of flexibility.

What’s prompting lenders to offer covenant-lite loans? 

The increase in covenant-lite loans is largely attributable to the large size and dispersed ownership of leveraged loans today.  As loans have gotten larger in size, the ownership has gotten fragmented.  Many leveraged loans now are widely held by a large number of banks and special purpose hedge funds, or collateralized loan funds. 

These large groups of lenders find it difficult to manage a loan with tight maintenance covenants.  The reaction, therefore, is to eliminate maintenance covenants in favor of other types of covenants.

Recent history has shown that companies with covenant-lite loans have performed comparatively well. 

Lenders in covenant-lite loans have recovered slightly more of their loan, in the event of trouble, than lenders in loans with maintenance covenants.  The sample involved, however, is small and the history short and may be biased by the limited historical availability of covenant-lite loans to larger, better credits. 

Despite the positive historical statistics, some credit agencies are sounding the alarm at the increase in covenant-lite loans predicting that lenders will have less control should there be economic trouble ahead.

So, while the credit market is still receptive to covenant-lite loans, this is the time for your company to consider refinancing. 

I’ve provided links to several interesting articles below.

Please contact me to help your company to refinance its debt or to complete any capital market transaction.

http://www.forbes.com/sites/spleverage/2013/08/14/covenant-lite-leveraged-loan-volume-soars-to-new-record/

http://blogs.reuters.com/felix-salmon/2013/05/31/dont-worry-about-cov-lite-loans/

http://www.loomissayles.com/internet/internetdata.nsf/0/0BF67A378755F21085257B5000566A43/$FILE/CovenantLitePaper.pdf

http://www.pehub.com/2013/09/05/covenant-lite-issuance-more-doubles-2013/#!

manbreakschain  Google

Venture Loan Terms

By Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com –

The law firm, Latham & Watkins, has been a great source for valuable webinars. Recently, I highlighted one on preparing for the 2013 proxy season (link).  This time, however, Latham produced a useful print article on venture loans.

 A venture loan is a niche loan used by private companies, often venture-backed, to get capital which is less expensive than equity.

In the article, the authors provide a list of deal terms and valuable commentary as to what is most common, in their experience.

I was surprised to learn about a “change in management default”, apparently a frequent term.  But the article covers many issues including typical loan maturities, covenants, collateral, prepayment provisions, etc.

Again, thanks to Latham & Watkins for continuing to provide helpful materials on the capital markets.

As always, please contact me to help your company to complete any capital market project.

Link to article: Checklist of Venture Loan Terms with Commentary
Google

High(?) Yield Bonds

Dennis McCarthy – (213) 222-8260 – dennismccarthy@ariesmgmt.com

New high yield bonds are now being issued at interest rates that don’t really qualify as high.

Forbes magazine reports that the 30-day average high yield new issue bond yield fell to 6.11% at the end of January.

If your company has debt outstanding in an amount of $100 million or more, your company should consider issuing high yield bonds at these historically low rates.

Many companies continue to borrow at short-term floating rates because those rates are amazingly low. Most likely, short-term floating rates won’t stay this low for 5 to 10 years, however. 

In contrast, today’s high yield bond rates present an opportunity to lock in low rates for a long period.

Also, short-term floating rate debt typically carries covenants that restrict a company. 

Again, in contrast, high yield bonds typically have very few covenants restricting the issuer. 

Please contact me to discuss raising high yield bonds or any capital market transaction.

Forbes article link: http://www.forbes.com/sites/spleverage/2013/01/22/high-yield-bond-yields-hit-record-low-6-11/

high-yield-bond-yield

Credit Bid Requirement Affirmed

 Dennis McCarthy – (213) 222-8260 – dennis@monarchbayassociates.com

The US Supreme Court has ruled on an issue important to bankruptcy professionals and secured lenders.

This US Supreme Court ruling clears up a split among US circuit courts and clarifies the rights of secured lenders.  In my opinion, it gives them greater leverage in bankruptcy.

The ruling involves what is known in bankruptcy practice as a “credit bid” by a secured lender.   In a credit bid, a secured lender can bid to buy the asset securing the loan by using the amount of the lender’s bankruptcy claim as if it was cash.

The US Supreme Court ruled that, in most instances, in order for a debtor to sell an asset securing a loan free and clear without a lien, the debtor is required to permit a secured lender to credit bid to buy the asset if the secured lender wishes.

A buyer of assets from a bankrupt business typically wants to buy the assets free and clear of any liens from the bankrupt business.  Therefore, the debtor effectively has to permit the secured lender to “credit bid” if he wishes.

For more information on the topic and the ruling, please see the two articles linked below.

 As always, please contact me to help you raise equity or debt or complete M&A transactions. 

Sheppard Article: http://www.bankruptcylawblog.com/other-nationally-significant-cases-canonized-creditbidding-the-supreme-court-unanimously-affirms-secured-creditors-right-to-creditbid-at-free-and-clear-sale-in-plan.html?utm_source=twitterfeed&utm_medium=twitter

Fulbright Article: http://www.fulbright.com/index.cfm?fuseaction=publications.detail&pub_id=5540&site_id=494&detail=yes

Flood of Corporate Bonds

Dennis McCarthy – (213) 222-8260 – dennis@monarchbayassociates.com

Right now, corporations are raising capital in record amounts by selling high grade bonds.

Can you blame them?  High grade corporate bonds are priced today at record low interest rates.

Even at these record low yields, investors are buying corporate high grade bonds in large volumes.

Investors are seeking interest rates that offer positive yields over inflation. 

The traditional source of yield for many investors, US Treasuries, seems no longer attractive.

 So, what’s the take-away here. 

You should at least consider raising capital through issuing corporate bonds if your company could rationally raise debt of roughly $100 million or more.

Contact me to discuss raising debt to capture this opportunity, or any capital market topic. 

www.lockinlowrate.com

 

Interest Rate Risk – “Preaching to the Choir”

Dennis McCarthy – (213) 222-8260 – dennismccarthy@ariesmgmt.com

“Preaching to the choir”.  In this case, the choir is me.  It seems that every commercial banker I meet, tells me to advise my clients, or anyone who’ll listen, to lock in today’s low interest rates.

When I ask, “what’s the risk?”, I get a lecture that we’re in an interest rate bubble and that despite the Fed’s announcement about the Fed Funds rate, business loan rates will likely rise, especially after the election.

When I confess that I not only believe them but share their concern, I ask “what should a company do to lock in these low rates?” 

Since most companies have floating rate business loans, the bankers’ most common recommendation is to enter into a swap arrangement to fix the rate.

The cost of the swap, especially after tax, is considered very low cost insurance relative to the risk of a rise in interest rates.

A swap is not the only way, however.  Some bankers recommended fixed rate term loans or even public bond issues if the financing is large enough. 

One of my clients raised its first high yield bond last week so I’m doing my best to help companies to reduce interest rate risk.  My banker friends would be pleased that their preaching paid off.

I can help your company to lock in low current interest rates.  Please contact me.  Thank you.

Visual Interest Rate History

On Youtube, next to my posts about interest rate risk such as “Behind the Headlines on Interest Rates” were a series of videos which visually chronicle the history of US Treasury interest rates along the maturity curve for the last 50 years with commentary by Dr. Donald R. van Deventer, founder of Kamakura Corporation. Displayed above is one of the videos entitled, “50 Years of Forward Rate Movements”.

In a great example of a picture is worth a thousand words, or in this case, 12,300 days of data, one can quickly sense (i) historical levels of benchmark US Treasury interest rates, (ii) the variations from the expected or classical term rate structure (which is more common than one would think), and (iii) the amazing volatility in benchmark US Treasury rates.

As my post “Behind the Headlines on Interest Rates” explains, there’s more to what a company pays in interest rates than just the benchmark US Treasury rates but this reveals the variability in those benchmarks themselves.

My thanks to Kamakura Corporation for creating these videos.  The company’s Youtube channel is www.youtube.com/user/kamakuracorporation and its website is www.kamakuraco.com.