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

Deal with a Slow Growth World

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

When I posted, “Living with no growth”, I suggested that we rethink some of our widely held assumptions, which are based on continued growth.

At that time, the most common response from viewers was denial, “no growth, not my world”.

And, to be fair, there’ll be pockets of growth, no doubt, but, in general, the global economy is slowing. There’s no denying it.

So, if you run a company facing this slow to no growth environment, how do you respond? 

Specifically, how do you deal with Wall Street when earnings growth is hard to come by?

The first response of many companies is to cut costs.  Many companies, however, are already running lean and mean so there’s not much room to cut costs any more, and some costs, for example, health and workers comp insurance, just keep rising.

The related response, raising prices is probably a non-starter in the face of today’s softening demand and increased competition.

So how do you keep Wall Street happy? Here are a couple more ideas.

One. Many public companies are initiating or increasing their stock buyback programs.

Last month, companies announced $45 billion in new or expanded stock buyback programs.

Two. Initiate or increase a dividend on your stock.  As I reported in my post Offer Yield Securities – What Investors Want”, increasingly, investors look for current yield if there’s slow or no growth.  And you know, with today’s low interest rate environment it doesn’t take much to offer an attractive yield. 

Three.  Your company could increase its financial leverage.  Your company could raise debt to grow or buyback equity. Borrowing rates are at record lows so you may be able to put the money to work efficiently to make this move pay.

Four. Get economies of scale by combining with another synergistic company.

If you can acquire or merge with a company at a reasonable price, you may be able to give your bottom line a boost by eliminating duplicate costs.

So, the message is, once we recognize that our environment has changed, that global growth is slowing, we can focus on practical responses

I can help you to evaluate your options and take the best actions.  Contact me now.

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.

Behind The Headlines On Interest Rates

 

The Federal Reserve announced that economic factors “are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

This will, no doubt, influence interest rates through this period, but this is not the sole determinant of a company’s interest rate as noted in my post “Seems Smart Now“.

For example, the debt market for corporations, both large and small, is influenced by supply and demand factors in addition to the benchmark federal funds rate.  The predicted reduction in demand for corporate debt by collateralized loan obligation (CLO) funds suggests that companies may see higher new issue interest rates.  In contrast, any increase in demand by other lenders such as high yield bond and “relative value” investors may ease rates.

The recent post, “No Loan Left Behind“, by Randy Schwimmer of Churchill Middle Market Finance, now a unit of The Carlyle Group, describes these supply and demand forces at work on the larger size loan market (size above $100 million).

To support Randy’s view that high yield investors are supplying critical demand, this week one of my clients successfully priced its first high yield bond replacing other financing sources.

My message is that while Fed action gets the headlines, there are several other factors at work, behind the headlines, which influence a company’s debt rate.

Dennis McCarthy

(213) 222-8260

dennismccarthy@ariesmgmt.com

Short-term Debt Seems Smart Now

dennismccarthy@ariesmgmt.com

(213) 222-8260

With short-term interest rates at historically low levels, many small cap companies are funding all their capital needs with short-term debt.

Can you blame them?  Small cap companies are borrowing at 2 to 3% floating rates or a bit more if swapped to fixed rates.

Yes, it is a short maturity, one to three years, but the lenders will extend it when due.  They said they would.

 Yes, we all know that old maxim, fund long-term assets with long-term capital but companies are saving so much in interest by borrowing short-term.

What’s the risk, anyway? If rates start to rise, companies can refinance with long-term capital then.

I hear this a lot.  It worries me.  

Interest rates may rise unexpectedly and fast.  When the time comes to lock in long-term capital, there’ll likely be a rush to refinance.

First,  who lends for 5 to 10 years – insurance companies, specialty lenders, the public bond market?

There are limits to how much and how fast these markets can absorb new debt.

Second, what will happen to interest rates?  Spreads on corporate debt have already widened since this summer.  What do you think will happen to interest rates when there’s a rush to refinance?

I’ve been encouraging small cap companies to be prudent, to borrow some capital long-term.  Create a relationship with the long-term debt market now, before the rush.

In the rush to refinance, you’ll want your company to be the first in line because your company is already a known participant in the long-term debt market. 

Now, that’s a smart move.

Please contact me to discuss this or any of my posts. Thank you.

Living with No Growth

dennismccarthy@ariesmgmt.com

(213) 222-8260

Lately, I’ve been struggling with what it will mean to live in a world of slow to no growth.

First, I tried denial.   There can’t be a world without growth.

Pick up any company annual report or analyst research report, they always project growth.

It’s in our Wall Street DNA.

We need growth to cover our costs, to justify higher salaries, to reward our shareholders?

But, what if, as is now widely expected, we face a global slowdown for our near-term future?

How do we behave in a slow to no growth world?

We’re going to have to rethink many of our basic assumptions. Here are a couple which come to mind.

First, I think cost control will become more critical without revenue growth to bail us out.

Will this trigger a power shift in companies?  Will the path to become CEO now run through accounting?

Second, I think that, without growth, current cash flow is king.  There’ll be more skepticism about the promise of future cash flow.

Will this spark a rash of corporate acquisitions as large, cash-flowing companies gobble up companies with no or low cash flow?

On the financing front, with slow to no growth, will companies borrow more to get as much financial leverage as possible.

Or, will equity securities change?  Will we see more companies begin to pay dividends or do regular stock buybacks to pay a current return to their equity shareholders.

These are just a few ideas.  There are many more potential implications.

Please contact me to discuss the capital markets implications for your company.

My contact information is below. Thank you.

dennismccarthy@ariesmgmt.com

(213) 222-8260

Capitalmarketalerts.com

Slow Road Ahead

Living with slow to no growth