Posts Tagged ‘Amend and Extend’

The Refinancing Cliff Is Coming

Wednesday, May 19th, 2010 by Ron Carleton

The problems of the last leveraged buyout  bubble are still with us.  From 2004 through 2007, the U.S. experienced an unprecedented level of LBO activity.  That all ended with the collapse of the debt markets in the summer of 2007 (and the disappearance of the debt markets after the Lehman bankruptcy).

LBO boom

LBOs are funded primarily with debt – somewhere between 60% and 80% of the capital structure.  These are the debt products used:

  • Institutional Term Loans (also know as “Term Loan B” or “TLB”) – often the single biggest tranche of debt, these loans are sold to institutional investors, such as collateralized debt obligations (CDOs) and prime rate funds.  They have very little principal amortization and a final maturity of 6-7 years.
  • Pro-rata Loans (comprised of a revolving credit facility and a Term Loan A) – these loans are sold to banks and typically make up a smaller part of the capital structure than the TLB.  Standard terms for a Term Loan A include significant principal amortization and a final maturity of 5 years.
  • High Yield Bonds – are sold to institutional investors.  They have a bullet maturity (i.e. no principal amortization) and a final maturity longer than the Institutional Term Loans, typically 7-10 years.

The Debt is Coming Due!

Starting in 2012, we will see significant amounts of LBO debt coming due.  Knowing the typical maturities of the debt products and counting forward from the boom years of 2006 and 2007, first we’ll see large amounts of pro-rata loans come due, then institutional term loans, then high yield bonds, as this chart shows:

refinancing cliff

What is the solution?

Highly leveraged companies have been working on this problem for some time.  Given their earlier maturities, much attention has been focussed on refinancing the loans.  Companies have issued new loans (with longer maturities) and high yield bonds in order to repay existing loans and extend their debt maturity profiles.  There have also been many “amend and extend” agreements whereby existing lenders extend the maturity of their loans (in exchange for fees, increased interest spreads and other consideration).

Looking out into 2012 and beyond, the question is whether or not there will be capacity in the loan and bond markets to refinance all of the maturing debt.  The jury is still out on this question.

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Jarden Compares Loan and Bond Costs

Tuesday, January 26th, 2010 by Ron Carleton

Jarden Corporation (Ticker JAH) is a diversified consumer products company whose brands include First Alert, Holmes, Mr. Coffee, and Sunbeam.  On June 30, 2009, it had approximately $2.7 billion of debt outstanding, half of which was in the form of Term Loans due through 2012.  Management was eager to begin refinancing these term loans in order to gain additional covenant flexibility and extend maturities.  Over the next 7 months, it completed two transactions.

 

August 2009: “Amend and Extend”

 

  • In August 2009, the company extended the maturity of $600 million of Term B loans (”TLBs”) from January 2012 to January 2015 through the creation of a “Term B4″ tranche.  This new tranche was priced at LIBOR + 3.25%.  The remaining $724 million of term loans remain due through 2012.
  • Along with the TLB extension, the company extended the maturity of $100 million of its (unused) revolver from 2010 to 2012 and amended the covenants on its loan facilities to allow for additional securitization and other indebtedness.

January 2010: Senior Subordinated Notes

  • In January 2010, the company completed an offering of 7.5% Senior Subordinated Notes due 2020.  The offering consisted of two tranches: $275 million offered in the U.S. and EUR150 (approximately $217) offered in Europe.
  • The company used a portion of the proceeds from this bond to repay a portion of its term loan, presumably those maturing through 2012.
  • The U.S. tranche was priced at 99.139, for a yield of 7.625%, or a spread of 385 basis points over the 10-year treasury.

 

So which is cheaper?
With LIBOR at 0.25%, the cost of the loan is 3.5% (i.e. LIBOR + 3.25%), while the bond’s effective cost is 7.625%.  So the loan is a cheaper source of capital than the bond?  Not so fast!  The loan is floating rate – if LIBOR goes up, the company’s interest cost will go up with it.  The bond is fixed rate – no matter what happens to interest rates, the coupon on the bond will not change.  So we cannot just compare the current loan cost of 3.5% to the bond’s cost of 7.625% – that would be comparing apples to oranges.

 

Combining a Loan and a Swap
In order to compare the cost of a fixed rate instrument (i.e. bond) to a floating rate instrument (i.e. loan), you must put them both on the same basis: either convert the bond to a floating rate or convert the loan to a fixed rate.  This is done using an interest rate swap.  Let’s swap the loan to a fixed rate, as follows:

Step 1: The company borrows at LIBOR + 325 basis points.
Step 2: In a separate transaction, the company agrees to make a periodic fixed rate payment to a bank, in exchange for which, the bank agrees to make a periodic LIBOR payment to the company.
The current quote for such an interest rate swap is about T+10:

  • The company will pay the bank a fixed rate of 3.875%, or 10 basis points over the current 10-year treasury rate of 3.775%
  • The bank will pay the company a floating rate of LIBOR, which will vary over the life of the contract.

 

These transactions can be expressed as follows:

 

 

 

 

 
 

 We can now calculate the effective fixed rate cost of the loan-swap combination:

 
 

 

 

 

 

 

 

  • Payment to loan holders:          LIBOR+325 basis points
  • Received from the swap bank:   LIBOR
  • Payment to swap bank:            Treasury +10 basis points

The LIBOR received from the swap bank offsets the LIBOR paid to the loan holders.  The net outflow from the company is the T+10 paid to the swap bank plus the 325 basis points paid to the loan holders, or T+335.  The 10-year treasury is 3.775%, so the effective fixed rate cost of the loan-swap combination is 3.775% plus 335 basis points, or 7.125%.

 

Why is the bond more expensive?  And why would the company issue the bond if it is more expensive than the loan?  Watch the blog for answers to these questions.

 

 

 

 

 

 

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Amend and Extend or Amend and Pretend?

Monday, October 19th, 2009 by Ron Carleton

In the last 6 months, we’ve seen a number of “amend and extend” transactions. Typically they involve:

  • The extension of the maturity of a term loan and/or revolver (typically for syndicated, non-investment grade loans). This is only for lenders who agree to the extension (i.e. some lenders may keep the original maturity
  • Increasing loan pricing for lenders who agree to extend (to reflect current market conditions and the higher credit risk of the borrower) and an amendment fee.
  • Covenant relief for the borrower (reflecting operating performance below original the targets).

Why an Amend and Extend?

During normal economic times, a borrower would do a new syndication as the maturity date for an existing facility approaches. So why are we seeing amend and extend agreements rather than new facilities? Because many of these companies would have a hard time getting a new syndication done. The loan market is much more selective for high risk credits, and many of these companies have high leverage and weak cash flows.

Amend and Pretend?

It is clear why a borrower would want an amend and extend (despite the higher cost) – they get covenant relief and one or two more years to turn around the business and generate cash for debt repayment. But why are lenders agreeing to these transactions? Do they really believe the borrowers will be able to repay the loans 2 years later, or are they just deferring the day of reckoning – the day when the borrower will need to do a major financial restructuring (or even a bankruptcy) and the lenders will have to write down the value of the loans? Is it an “amend and extend” or “amend and pretend” (that the loan will actually be repaid some day)?

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