By Dwight Cass
Loan and bond market recoveries have treasurers reconsidering their capital structures, but risks remain.
The ongoing rally in the capital markets and the slow-but-steady improvement in the loan market have many treasurers scratching their heads. Should they attempt to term out their bank debt in the capital markets—or at least stretch tenors in the loan market? Or should they bet that capital markets will remain accessible and use them to finance on an as-needed basis, bypassing recalcitrant banks? Cash piling up on many balance sheets further complicates the equation.
This was one of the pressing topics at the meeting last month of The NeuGroup’s Treasurers’ Group of Thirty, sponsored by HSBC. The group is weighted toward large investment-grade companies, but has a few leveraged borrowers in the mix. And developments in the junk markets, which can foreshadow those in the high-grade markets, have been pretty remarkable.
For example, despite banks’ ongoing balance sheet and regulatory woes, the past month has seen the re-emergence of covenant lite loans. Take Lyondell Chemical’s $500 million facility arranged in late March. Yield-seeking loan buyers’ demand allowed the arrangers to strip out maintenance covenants and cut the spread on the deal by a quarter-point, to 400bp over Libor—mind you, this is for a company just exiting bankruptcy. A junk bond offering to round out the exit package met with equally robust demand.
BLASTED INVESTORS
The junk bond market also took a step back in time last month with the re-emergence of the PIK toggle structure. Freedom Group, a gun manufacturer, floated the first PIK toggle of the year in a $225 million offering. While these deals are expected to remain rare—indeed, some issuers who formerly chose the PIK option have recently flipped the switch to pay cash instead—Freedom is a notable bellwether of investor appetite.
Investment-grade bond investors are showing more temperance, at least according to a recent Wall Street Journal article, and are demanding ratings-triggered step-up clauses of 25bp or so to get comfortable with issuers’ commitment to remaining out of the junk realm.
“If you have a long time left on your revolver you have two camps — you can get a longer term at a higher price now, but it sounds like there’s an advantage to waiting because of the uncertainty.”
— T30 treasurer.
The investment-grade loan market is also evolving. According to T30 members last month, four-year tenors are starting to appear, although at the time of the meeting, there had been no five-year benchmarks. Members suggested this is due to 1) no one wanting to be the first (although some aggressive borrowers have revolvers coming due this summer) and 2) worries over the fallout from pending US financial reform legislation and new capital regulations for banks, which have both borrowers and lenders taking a wait-and-see approach.
TIMING THE MARKETS
The difficulty deciding whether to refinance, term out or stand pat were starkly demonstrated in early April, when the 10-year Treasury yield punctured 4 percent for the first time in ages, and many lower-rung corporate credit spreads, especially in Europe, bulged temporarily when the Greek bailout looked in jeopardy. Market tremors like these, along with growing shareholder pressure to return cash, makes this multivariate equation particularly difficult to solve.
Still, the temptation to tap the markets is strong. One treasurer at a BBB rated company recently raised 30-year money at 170bp over treasuries, a deal he said made a lot of sense despite his having plenty of cash on hand.
But does it make sense to ignore improvements in the loan markets, even if you’re stuffed with cash and don’t expect to ever have to draw on a facility? After all, a revolver provides another way to access liquidity, and although it may be currently somewhat costly, having a belt-and-suspenders strategy appeals to many treasurers. The answer to that involves a number of considerations:
- There’s the math of determining the tradeoff from the negative carry on a bond versus the cost of the revolver.
- There’s the trade-off of having liquidity in terms of a larger bank line versus cash on your balance sheet; some treasurers favor the former.
- There’s the pressure to return cash to investors or, as some analysts are euphemistically saying, “optimize your balance sheet”—which is code for leveraging up.
- It’s also easier to get past a credit committee when you renew a revolver, rather than letting it expire and having to argue your case anew when you need to set one up later.
One treasurer who works for a company that is currently cash flush, but in the past ran into trouble and had its banks request that it not draw its revolver, said it was seriously considering letting the facility expire. The capital markets’ receptivity buttressed this view. But the last two considerations above should be seriously considered by treasurers in similar circumstances before they act.
The calculus of deciding whether to refinance, term out or wait-and-see will be different for each company. Luckily, the market trends appear to be moving inexorably in borrowers’ favor. Nonetheless, treasurers will need to keep a sharp eye on the news—bank regulations, exogenous shocks like Greece and developments in the Treasury market could all weigh heavily on their capital structure decisions. And as the recent crisis taught, markets can reverse with dizzying speed.