4 Debt Markets Update - PwC UK€¦ · Debt Advisory – Debt Markets Update Summer 2010 1 4 Introduction 4 Spotlight - Asian Debt Markets 4 Corporate Lending 4 Corporate Bonds 4

Debt Advisory – Debt Markets Update Summer 2010 1

4 Introduction

4 Spotlight - Asian Debt Markets

4 Corporate Lending

4 Corporate Bonds

4 Asset Based Lending

4 Leveraged Finance

4 Restructuring

4 Our Debt Advisory services

4 What we do

4 Selected recent transactions

4 Contacts

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Debt Advisory

Debt Markets UpdateSummer 2010

Advisory


4 Introduction


4 Corporate Lending

4 Corporate Bonds


4 Leveraged Finance

4 Restructuring


4 What we do


4 Contacts

4Home

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It has been an uncertain three months for borrowers, lenders, issuers and investors with the continuing euro-zone debt crisis and renewed economic doubts restricting supply in the debt capital markets and dampening the demand for new lending (particularly that related to M&A activity).

UK corporate lending was therefore relatively quiet in Q2 with borrowers and lenders alike waiting for the outcome of the UK’s general election and emergency budget. An uplift in the regulatory capital requirements for banks envisaged under the upcoming Basel III regime hangs over the sector and will increase the relative importance of the capital markets as a source of funding in the medium term.

As Vince Cable has said this month, in the context of widely quoted research by PwC, “There is a fundamental policy conflict between efforts to make banks safer and our wish to get them lending more freely to promote growth.”

There has been a steady flow of new LBO deals over the last six months, but we should not forget activity levels are the lowest since the late 1990s. There is renewed appetite from CLOs and other investment funds for leveraged loans and banks are increasingly willing to take

underwriting risk so in our view the market is demand rather than supply constrained. We need an improvement in animal spirits before leverage loan volumes can properly recover.

The rollercoaster ride in the bond market over the last quarter is a salutary reminder of the vagaries of the capital market. Those unreliable banks look a little more supportive compared to a year ago. However, the high yield market has steadied itself over the last month and PricewaterhouseCoopers would expect a continuing stream of issues for the remainder of the year, barring another exogenous shock.

On the debt restructuring front, payment defaults and new formal restructuring discussions are substantially lower than a year ago, covenant resets less so. This perhaps indicates we are through the worst of the restructuring cycle. However, whilst the maturity wall continues to be chipped away by new bond and leveraged loan issuance, we still expect that a significant pool of the more highly leveraged borrowers will require formal restructuring to address their gearing issues.

Against the backdrop of the ongoing liquidity squeeze in Europe’s domestic

markets, corporates may have to go further and work harder to secure capital, and our ‘spotlight’ in this edition falls on the debt capital markets of the Asia-Pacific region including Australia. The potential for UK and European borrowers to seek funding in Asia-Pacific markets took a step forward in Q2 2010, where the lending capacity of Asian banks is supported by strong economic growth in the region. However, care should be taken as each Asian banking market is very different from the next in terms of regulatory framework, financial strength and appetite for international credit.

Overall the debt markets look set for a quiet summer and only by Q3 will a clearer – and hopefully more positive - longer-term picture begin to emerge.

Introduction

Simon Boadle Head of Debt Advisory PricewaterhouseCoopers LLP Tel: +44 (0)20 7212 4118 Email: [email protected]

Welcome to the Summer 2010 Debt Market Update from the Debt Advisory Team at PricewaterhouseCoopers (PwC), which looks at credit market trends during the second quarter of 2010 and the outlook for the rest of the year.


4 Introduction


4 Corporate Lending

4 Corporate Bonds


4 Leveraged Finance

4 Restructuring


4 What we do


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Spotlight - Asian Debt Markets•

Corporate Lending•

Corporate Bonds•

Asset Based Lending•

Leveraged Finance•

Restructuring•

Our Debt Advisory services•

What we do•

Selected recent transactions•

Contacts•

Contents


4 Introduction


4 Corporate Lending

4 Corporate Bonds


4 Leveraged Finance

4 Restructuring


4 What we do


4 Contacts

4Home

4Print

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Spotlight: Asian Debt Markets

The potential for UK/European borrowers to seek funding in Asia-Pacific (A-P) markets took a step forward in Q2 2010, as the sovereign debt crisis in the Eurozone raised once again the spectre of an ongoing liquidity squeeze in Europe’s domestic markets.

The lending capacity of Asian banks is supported by strong economic growth in the region. According to the IMF, economies in emerging Asia (excluding Japan, Australia and New Zealand) are forecast to expand by 8.7% his year. This compares with anticipated growth of just 1% in the Eurozone. Asian economies have also been traditionally less debt-dependent and less than US$41bn of writedowns are forecast in the region from the 2008/09 credit crisis, compared to ECB estimates of €195bn for European lenders, in the period to end-2011. Unlike their European counterparts, many of which continue to shrink balance sheet lending, many Asian banks are increasing their risk assets and expanding market share. Indeed, some Asian banks talk of climbing Arranger league tables through leading large financings; such talk has been unheard of in Europe over the past couple of years.

The development of Asian markets may provide opportunities for international borrowers to target fundraisings with lending institutions in the region. In the past, such institutions typically sought to participate in larger regional or global offerings. One of the key drivers of this development has been the limited liquidity and pricing pressures in other markets, which has not been mirrored in a number of Asian markets. There is mutuality of interest; international borrowers may achieve pricing and terms materially better than those available in ‘home’ or adjacent markets, whilst Asian lenders can generate better returns - for often better credits - than those available from local borrowers. Borrowers have responded by recognising Asian markets as a source of additional funding diversity and not necessarily as ‘only’ an extension of their existing bank funding lines.

In May, the privately-owned Swiss commodity trader Glencore International, Geneva-based energy trader Gunvor International and Ghana Cocoa Board tapped into Asian markets. Glencore Singapore (with Glencore International as co-borrower) raised $475m from Asian lenders for the first time (as part of a wider syndicated loan facility). Participating banks in the Asian tranche included Industrial &

Commercial Bank of China - the world’s largest lender by market value, Bank of China and China Construction Bank.

Many Asian banks have an international presence with corporate lending offices in London and other European financial centres. It is primarily, though not exclusively, these banks which have appetite for European corporate credit. As such, many European borrowers may have already tapped the A-P liquidity pool through European offices of Asian banks participating in their syndicated facilities. Irrespective of where the lending office is based, A-P lenders will typically look for the following features in an international lending opportunity:

strong support from at least one leading • bank in the issuer’s home market. Ideally, this bank will also have a presence in Asia;

‘blue-chip’ name borrowers, with a formal • investment grade (or equivalent internal bank) credit rating;

ideally, though not essentially, operations • in Asia or at least some Asian ‘angle’ to their business. Some Asian banks, for example the Chinese state-owned banks, have provided funding for strategic reasons, including securing supply of important commodities or in support of key trade relationships.


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Spotlight: Asian Debt Markets (continued)

Attractive pricing dynamics in A-P markets are evidenced in numerous sub-100bps issuances over the past 6-9 months, albeit this pricing is largely reserved for local blue-chip issuers with strong, established banking relationships. It is unlikely that foreign issuers with no Asian presence would be able to attract liquidity with such pricing.

The A-P region should not be considered as one, homogenous loan market. Each Asian banking market is very different from the next in terms of regulatory framework, financial strength and appetite for international credit. For example, Korean banks will behave differently to Chinese or Taiwanese banks. Notwithstanding this, some similarities are also observable: credit processes can often be protracted and unpredictable and, like their European counterparts, Asian banks can demonstrate a herd mentality, such that one Taiwanese bank gaining credit approval for a new international borrower is likely to increase the chances of other Taiwanese banks following, with the reverse also being true.

Australian bond markets are more likely to respond to international issuers than Australian banks. The Kangaroo bond market has reopened to corporate issuers

following a short GFC-infused shutdown, with the likes of Volkswagen, Holcim and Caterpillar all issuing in the past 12 months. However, these issuers are all repeat issuers in the Kangaroo market and it is likely that appetite for first-time issuers will be limited to top-tier, highly rated corporates. Australian investors, like investors around the world, continue to be concerned about global market conditions and the prospects for corporate earnings. Consequently, tenor availability remains limited for all but the highest quality credits and has yet to become materially more favourable than other competing markets such as the US Private Placement market and even selected pools of European fixed income investors.

A further development which may be of interest to asset-rich European borrowers, is the encouragement given by some Asian Governments, such as the Government of Malaysia, to the development of alternative funding markets. The Malaysian Islamic Finance Centre, part of Bank Negara (Malaysia’s Central Bank) is actively engaging with other governments in the region and elsewhere around the world to enable the relevant legislative and regulatory framework for efficient access to a growing pool of funds for Shariah-compliant investment. The key elements of many

Shariah-compliant financing structures can also be found in many conventional funding solutions and, therefore, this liquidity pool may offer a deliverable financing alternative for prospective borrowers. The Debt Advisory Group at PwC (UK) has recently assisted a UK construction company with worldwide operations investigate the benefits of Shariah-compliant financing, as a potential means of accessing additional sources of liquidity.

The Debt & Capital Advisory business at PwC Debt Advisory business at PwC (Australia), led by Mike Branson and Matt Santoro, has assisted clients in considering, exploring and implementing their strategic capital plans. Mike and Matt each have in excess of 20 years experience in international debt capital markets and they have, together with the Debt Advisory Group at PwC (UK), been actively engaged this year with a number of clients addressing and advising on many of the issues raised in this Spotlight feature.


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Lending volumes – Q1 froth goes flatAfter signs of resurgent activity in Q1, the volume of investment grade financings signed between April and June fell back by 40%, to 21; however, at £453m, the average size of transaction almost doubled compared to the preceding quarter, meaning that aggregate transaction value for the quarter actually increased to £9.5bn.

Chart 1: UK volumes - Investment Grade (AAA-BBB-) Corporate Lending

Source: Dealogic LoanAnalytics

Corporate Lending: Positive sentiment continues to be tempered by a cloud of uncertainty

Key trends

The UK corporate lending market was relatively quiet in the second quarter of 2010, which was disappointing following the positive trends seen in the first quarter. Borrowers and lenders alike appeared to be waiting for to see the outcome of the UK’s general election and emergency budget, with the various sovereign debt concerns also subduing confidence.

Despite this aura of caution we continue to see signs of liquidity improving, with the UK government re-enforcing lending targets in those banks in which it has a shareholding and debt maturities continuing to lengthen. Several new lenders have also entered the arena and there is evidence of some banks increasing hold levels in specific instances.

Early discussions have started between banks, regulators and advisers around the introduction of Basle III – the latest iteration of rules designed to ensure that banks have sufficient capital. Early views are that this next round of regulation, when introduced at the end of 2012, is likely to further reduce the lending capacity that banks have.

Whilst the supply-side story is generally more positive, M&A activity has remained at a low ebb and therefore demand for new debt – as opposed to refinancings - has continued to be weak. There has also been relatively little call for expansion capital with a large number of strategic plans on hold until the trading outlook becomes more certain. However, the ongoing shadow of the ‘maturity wall’ is never far away and does need to be built into future planning considerations. To some extent the size of this problem has been eased by the ability, for larger financing requirements, to be funded through the capital markets, but there is always the risk that appetite in these markets suddenly wanes.

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Room for optimismOverall we still see bank market sentiment as continuing to move in a positive direction with most banks now appearing to have increased lending capacity and being prepared to “use” it. This has been seen through both increased “hold” levels in some banks and by the gradual reintroduction into the market of banks that have stood on the sidelines for the past couple of years.

Most banks are now talking about having an appetite to underwrite debt funding, however the demand for underwriting comes mainly from M&A activity – which is still very subdued – and therefore there have been very few underwrites in practice. In the event that a sizeable underwritten debt package is required, we would expect banks to price this aggressively to ensure they mitigate potential syndication risks.

Appetite for riskThere will always, correctly, be a tension between the commercial desire for banks to lend and their need to control risk – exercised through their credit departments. The balance of power between banks’ origination and credit functions varies through an economic cycle and over the last few years has very much been with the credit side “in the ascendancy.” During the expected recovery phase of both economies’ and banks’ balance sheets, we would expect a continuation of this leaning towards caution which will, in some instances, still mean good lending propositions being declined. In our view it is critical that the originators, or sales teams, in banks are able to accurately judge their institution’s appetite so as to be able to manage client expectations correctly. In our recent experience, some banks have better track records than others in this regard.

Pricing The chart suggests that average pricing for new investment grade lending has increased during the quarter. Our suspicion is that the suggested movement is skewed by the relatively small sample size and/or the premium being sought by lenders for the longer maturities now increasingly available.

The sense that we have from our regular discussions with lenders into mid-market (sub-investment grade) businesses is that pricing has seen little movement, up or down, through the last quarter.

Chart 2: UK Investment Grade (AAA-BBB-) average margin over LIBOR/EURIBOR


Corporate Lending: Positive sentiment continues to be tempered by a cloud of uncertainty (continued)

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Client considerations

Debt maturity remains topical with companies focusing on the best way of scaling the ‘maturity wall’ ie refinancing the relatively large proportion of loan agreements due to expire in 2010-2014.

We are seeing that most borrowers who allow sufficient time to address their refinancing are able to secure new facilities (other than distressed credits).

Companies should usually consider their refinancing around 18 months ahead of maturity, consult banks and advisers early and not be afraid to explore all possible funding avenues to secure the best new arrangements. Indeed we are seeing increasing use of capital markets instruments alongside traditional debt facilities.

Corporate Lending: Positive sentiment continues to be tempered by a cloud of uncertainty (continued)

Outlook remains positiveOur view of the UK corporate debt market for 2010 remains broadly positive although caution will continue to be the watch word. All eyes will be on the impact of the new government’s emergency budget and whether the UK economy continues its recovery.

The summer months are proving relatively quiet with some expectations of an upturn in lending activity anticipated going into the last quarter of 2010.

Looking further ahead, into 2012 and beyond, the introduction of Basel III regulations may place further limitations on the sizes of bank balance sheets and therefore impact liquidity.


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Volumes hit by sovereign debt concerns Growth in the UK corporate bond market slowed significantly in Q2 2010. Between April and June 2010 the value of all UK bond issuance fell to €5.9 billion from €10.0 billion in Q1, and was the lowest level of bond issue since before 2008.

Chart 3: All UK bonds issued by rating (€bn)

Source: Dealogic DCM

Corporate Bonds: Euro-zone sovereign debt crisis temporarily stops burgeoning UK bond market in its tracks

Key trends

May and June are traditionally busy months for the bond markets as companies rush to complete financings ahead of the summer holiday season. In Q2 this year, however, the European sovereign debt crisis and uncertainty in the UK generated by the general election and subsequent ‘emergency’ budget combined to put the brake on UK corporate bond issuance with activity not only well down on Q1, but at the lowest level since before the global credit crisis and recession.

Although current market levels still provide attractive coupons for issuers compared to recent market averages, pricing has begun to inch up once again. Investors have become unsettled, concerned that yields are now too tight for the macro-environment.

The high yield bond (HYB) market was particularly hard hit this quarter, notably by the fears of ‘contagion’ from the euro-zone. However the market rebounded in June, a trend which has continued into July.

Whilst Q2 provided a salutary lesson in the vagaries of the capital markets, we still believe the medium term trend is for companies to diversify away from bank lending. To this end, private placement volumes remained stable in Q2 as companies sort to lengthen their maturity profile.

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Corporate Bonds: Euro-zone sovereign debt crisis temporarily stops burgeoning UK bond market in its tracks (continued)This was due, largely, to fall-out from the euro-zone debt crisis. The average issue size in Q2 was €349 million compared with €435 million Q1.

The investment grade market has been dominated by issues from utilities and transport companies. Porterbrook Rail Finance raised €610 million and National Express Group €272 million while in the utilities sector Yorkshire Water (Kelda Group) issued a €723 million bond and AWG (Anglian Water Group) €150 million.

Volumes were down across the board impacting both investment grade and high yield bonds. In Q1 2010, HYBs accounted for 40 per cent of the total UK bond market. In Q2 this was reduced to 35 per cent with volume falling from €4.1bn to €2.1bn. The largest HYB issues in Q2 were by INEOS with a €735 million issue to repay existing debt facilities and International Power with €250 million.

The quarter was characterised by low levels of issuance in May and a return to lending in June and this coupled with significant issurances such as Care UK’s, €250 million issue and Gala’s proposed €600 million bond in July indicates a strengthening in the market.


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Corporate Bonds: Euro-zone sovereign debt crisis temporarily stops burgeoning UK bond market in its tracks (continued)Pricing eases upwardsFrom their peak in Q1 2009, UK corporate bond spreads had been falling consistently on most new issuances to bring pricing in line with levels last seen in late 2007. However, driven by the fear-factor among investors, average spreads increased slightly in Q2.

In the investment grade market, average spreads in Q2 2010 for A and BBB issues were 258bps and 336bps respectively. This compares with 206bp and 268bp in Q1. Lower down the spectrum, Q2 BB and B issuance was respectively 728bp and 872bp compared with 619bp and 653bps in Q1.

Chart 4: UK issues by sector (€bn)


Age of maturityWhile three to five year maturities are the ‘norm’ in the commercial bank debt market, corporate bonds offer the possibility of longer horizons – a key attraction for issuers.

As part of its ‘liability management’ exercise (buying back old bonds and issuing new ones to take advantage of low yields, extended maturities and reduced carrying costs); British American Tobacco (BAT) recently issued a new dual-tranche €600 million and £275 million sterling transaction. The tenor on the euro tranche was ten years while the length of the sterling portion was 30 years – the longest ever sterling issue from a tobacco company.

Chart 5: UK Corporate Bonds - spread over government debt by rating



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Corporate Bonds: Euro-zone sovereign debt crisis temporarily stops burgeoning UK bond market in its tracks (continued)High yield bond marketAfter its surge in Q1 the UK’s HYB market was knocked-back in Q2. The market may, however, have been due for a correction having begun to over-heat following its acceleration over the previous nine months from a standing start in 2008/9. The market did re-open in June with c €3.0bn of issuances across Europe and further new issues in July.

The fixed costs of a HYB issue require a minimum issue size of c.£200m. But HYBs offer significant advantages over bank debt both in terms of the quantum that can be raised and the tenor that may be available (typically five to seven years).

Private placements perk upAfter a dismal Q1, private placements were a notable highlight in the bond market in Q2. Issuance reached some €1.8 billion – up from €1.4 billion in Q1.

Private placements in Q2 encompassed a wide range of industry sectors, with placements by:

Meggitt - $600 million; •

Capita - $375 million; •

Howard de Walden Estates - $150 million; •

Whitbread - $140 million; and •

Northern Foods - $100 million. •

Illustrating the pent-up demand among investors, several of these issues were upsized from their initial launch size. Tactically, issuers will often go for a relatively modest issue to test market demand before either upsizing the issue or shaving back the pricing.

Although historically more expensive than bank debt, private placement spreads have fallen to make this an attractive funding option for corporates, especially when coupled with the relatively long tenors available – typically seven to ten years.

Chart 6: European private placements (all sectors excluding finance) (€bn)



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Corporate Bonds: Euro-zone sovereign debt crisis temporarily stops burgeoning UK bond market in its tracks (continued)Outlook – market set to overcome Q2 ‘blip’Despite recent fears surrounding the sovereign debt crisis in the euro-zone and the risk of a ‘double-dip’ recession, the longer-term trend in the UK corporate debt market remains generally positive.

The HYB market will recover with demand continuing to be driven by the large number of bonds issued in the last surge in 2004/5 and due to mature in 2011/12. While the UK corporate bond market in general may be hit by the traditional summer slowdown, private placements are expected to continue to strengthen throughout 2010.

In the medium-term there is a concern that the EU’s solvency II guidelines, due to be implemented in 2012, could force insurance companies to restrict their investment in certain asset classes and limit future growth in the sector. However discussions are continuing on the precise implementation of the rules.


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Corporate Bonds: Euro-zone sovereign debt crisis temporarily stops burgeoning UK bond market in its tracks (continued)


The ups and downs of the capital markets aside, the bond market remains an • important tool for mid size and larger borrowing to diversify sources of capital and spread the maturity profile.

Some corporates have been using HYBs as an alternative to IPOs since they offer • both a means for shareholders to realise value and raise new money without the uncertainties and dilutive impact of equity issues. It can be sensible to run IPO and HYB scenarios in parallel.

With credit ratings a key driver to the pricing of corporate bonds and private • placements, corporates should ensure they obtain the best possible rating by presenting their business to the agencies in the best possible light.

Borrowers with a smaller level of long-term core debt should consider the private • placement market to replicate some of the benefits of tapping the capital markets.

Companies with relatively high levels of leverage, but not in financial distress, should • consider the high yield market to address up coming maturities.


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Asset-based lending: Less M&A activity, but still attractive to re-financing corporates

Key trends

The order book for asset-based lenders (ABLs) weakened slightly in Q2 2010, undermined by slow down in mid-market M & A activity and a general decline in business confidence. In particular the PE market, which was a significant user of ABL in Q1, became more subdued as the sovereign debt crisis in southern Europe and the persistently cloudy economic outlook kept dealmakers at home.

Yet despite the challenging market place, ABL remains a relatively attractive form of financing. It is competitively-priced with margins still continuing to ease down. Margins are particularly keenly priced for the largest, best quality deals with ABLs starting to compete for larger ‘holds’.

Furthermore, for some companies, particularly those which are asset-rich and cash flow poor - a segment of the market particularly hit by the credit crunch – ABL is often their only remaining source of funding.

Order books weaken as deal market remains flatWe have recently detected a slowdown in the ABL market (although definitive data for Q2 2010 was not available at time of publication) with lenders and prospective borrowers alike pausing to assess the impact of the General Election and ‘austerity budget’ against a backdrop of euro-zone sovereign debt concerns.

We believe order books for asset-based lenders (ABLs) to have weakened slightly in Q2 2010, undermined by a decline in mid market M & A activity and a general reduction in business confidence. In particular the PE market, which was a significant user of ABL in Q1 became more subdued as the sovereign debt crisis in southern Europe and the persistently cloudy economic outlook kept dealmakers at home.

Total advances for Q1 2010 stood at £14.1 billion in line with the Q4 2009 level. The majority of this figure - £11.5 billion – was accounted for by invoice financing with around £2.4 billion of comprehensive ABL ie senior debt provided, and secured, against a range of assets in a single structured finance package.

Rising ‘hold’ sizes and slimmer marginsTrends identified at the end of 2009 with hold sizes rising, the upper end of margin ranges decreasing and a growing number of transactions funded by an ABL/mezzanine blend (replacing the cash flow lending ‘top-ups’ common pre-credit crunch), have still held good in 2010.

In terms of ABL appetite, we acted on a recent £55 million asset-based refinancing. This was a two-bank deal with both existing ABLs decided to stay in, but had either decided to exit we would have had no difficulty in finding new lenders to take their place.

Some major ABLs are now considering hold sizes of up to £100 million. This reflects the appetite to lend within the ABL sector and the fact that good quality deals remain in short supply.


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Asset-based lending: Less M&A activity, but still attractive to re-financing corporates (continued)

Falling asset valuations hits debt advancesDespite the challenging market place, ABL remains a relatively attractive form of financing. It is competitively-priced with margins continuing to ease down from their peak. Average margins for receivable and inventory lines now stand at 175 to 300bps over Libor and 275 to 350bps for term debt secured over property, plant and machinery.

Lenders continue to typically be willing to advance up to 85 per cent of receivables with lower advances for plant and machinery (up to 50 – 70 per cent of 120-day realisable value), property (up to 50 – 70 per cent of 180-day realisable value) and inventory (up to 20-50 per cent).

Fixed asset realisation values, particularly for plant and machinery but also for industrial property, have fallen significantly over the last two years. This has reduced the quantum of finance available against these assets.

Higher risk candidatesWhile Q1 saw the engineering and facilities management group Jarvis, which was backed by a £50 million facilities from two major ABLs, go into administration. Q2 2010 has fortunately seen no such major failures.

However, ABLs will often back turnaround businesses and so their clients will necessarily be higher risk. For some companies, particularly those which are asset-rich and cash flow poor - a segment of the market hit particularly hard by the credit crunch – ABL may be their only remaining source of funding.


Clients must be aware that a marked • downturn in trading can have a particularly strong impact for an ABL-backed business. It will not only suffer trading losses but also a reduction in working capital assets to fund against.

It is critical to an ABL’s funding criteria • that advance rates are sufficiently conservative for it to be confident it can recover its lending in full in the event of an insolvency situation. Therefore, once lending requirements go beyond those advance rates, the right commercial decision for the ABL will be to recover its lending rather than to advance further funds .


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Leveraged Finance: Encouraging progress as the market awaits an upturn in M&A activity

Key trends

The tide in the European leverage finance market began to turn almost exactly 12 months ago and this slow, but steady, progress continued into the second quarter of 2010. Although the recovery remains fragile given the volatile capital markets, continuing economic uncertainty and euro-zone turbulence; new leveraged financing opportunities – and funding sources - are continuing to appear.

Improvements in business performance, strong appetite in capital markets and increased overall liquidity in primary debt markets (syndications) have increased confidence for funders and issuers. Increased confidence has also sparked competitiveness amongst arrangers and as a result leverage appears to be edging up once more, combined with a levelling off in pricing.

One reason for an increased appetite of banks to underwrite debt is their re-newed confidence in the syndication market. This is driven by the re-entering of ‘participation only’ lenders (i.e. lenders that do not have the appetite or capabilities to underwrite debt), a revival in collateralised loan obligations (CLOs) – following cash inflows over the past months and recent activity in the US – and the emergence of several specialist mid-market investment vehicles.

This is helping the market to move on from the limited syndication pool of commercial banks to a pre-crunch model which includes CLOs and other loan funds - a trend which is changing the market dynamic. In addition, capital markets remain an option for consideration, although recent market turbulence has reminded arrangers and borrowers that these markets can be quite volatile.

Market continues to move forwardThe volume of new syndicated loans in Western Europe was €7.5bn in Q2, in line with activity in Q1. Year-on-year this represents modest growth over H109 issuance of €11bn, but is still massively down on H108 (€35bn). Moreover, the volume of loans to support buyouts shrunk in Q2 to €1.7bn from €2.9bn in Q1 (although the number of deals held up). This reflects relatively low levels of M&A activity but also a couple of deals which were all equity financed prior to a high yield bond raise. Overall, two thirds of new leveraged loan this year have been to refinance existing deals.

A more positive trend has been banks increasingly willingness to compete for (lead) underwriting mandates. Some examples in Q2 include BC Partner’s acquisition of French cleaning products maker Spotless and the acquisition of Care UK by Bridgepoint (although senior facilities for the latter may be replaced by a bond issue). The successful syndication of these transactions may further strengthen the confidence of lenders.

Post-credit crunch, the market has developed from the limited syndication pool of commercial banks only to a more liquid market which now includes CLOs and other fund participants with underlying investor groups and this is changing the market dynamic.

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Chart 7: European LBO volumes

Source: S&P LCD


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Leveraged Finance: Encouraging progress as the market awaits an upturn in M&A activity (continued)

New sources of fundingWith traditional participating banks now back firmly in the LBO arena and CLOs and other debt funds also re-entering the fray, the European leveraged finance market continues to strengthen and deepen.

CLOs have shown renewed lending appetite recently, helped by significant repayments over the past nine months. Although conditions for new vehicles remain difficult, this year has also seen the launch of some new CLOs in the US with Europe likely to follow suit.

COA Tempus CLO, the first arbitrage CLO in more than a year, was issued in April this year. At $525 million it is managed by Fraser Sullivan, the New York-based investment manager. It was followed, in May, by the launch of Apollo Credit Management’s $325 million ALM Loan Funding 2010/11 long-term debt CLO.

Another interesting development is the return of traditional fund managers to the debt market. Before the emergence and subsequent dominance of CLO funds, bank

loan mutual funds were a major source of liquidity in the leveraged market. When CLOs arose they were largely pushed out but now see renewed market potential.

In April this year the European asset manager Alpstar Capital launched Alper European Credit Fund. This investment vehicle, which aims to reach some €250 million by 2011, will focus on European credit including HY bonds and loans, sourced from primary and secondary markets. AXA IM has been seeking to raise a new €500 million open-ended loan fund while HarbourVest recently moved into the senior debt market for the first time with the completion of a £101million fundraising.

In doing so these funds join specialist debt funds such as Haymarket Financial, Ares Capital and Sankaty Advisors which have taken advantage of opportunities in the mid-market during the credit crunch. These specialised debt funds may be able to provide bespoke solutions and offer borrowers more choice in terms of structure and pricing.

High yield bonds remain buoyantThe high yield bond market has been active since Q2 09. Whilst there was a hiatus in May 2010 in reaction to a general increase in risk aversion, the high yield market has re-opened with €3bn of issuance in June.

Only 7% year-to-date issuance to June has been used to support new buyouts, which reflects a general focus on refinancing. However recent issues by Care UK and DFS indicate sponsors are making more use of the products to support buyout activity.


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Pricing stays levelAverage margins for leveraged loans in Q2 were Libor + 425bps and L +475bps on senior A and B respectively chart 8. This confirms our observation in Q1 that margins appear to have levelled off.

Chart 8: European weighted average new issues spreads

Source: S&P LCD

For larger deals, competition from bond issues has driven mezzanine margins down from the high teens of 2009 to L + 1500bps in Q2, or even lower. However, volumes remain muted at just €600m in the first half of this year across eight transactions. The dearth of new issues reflects low M&A activity, growth in high yield issuance the relative cost of mezzanine and the willingness of PE houses to deploy capital in buyouts. Arrangement fees remain at around four per cent on senior debt.

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Gearing goes upDebt multiples appear to be slowly creeping up again although increased leverage is still reserved for the best assets. Average debt to EBITDA multiples increased slightly in Q2 to the region of 3.7x for senior debt and 4.1x for total leverage.

Lenders seem willing to increase leverage even further for selected transactions as seen in recent deals such as PAI’s acquisition of Cerba European Lab and AXA Private Equity’s acquisition of Go Voyages (both at appr. 5x total leverage).

Purchase price multiples have moved in line with the increase in leverage multiples with equity contributions remaining at c.50% in H1 2010.

Chart 9: Sources of proceeds as a multiple of EBITDA of European LBOs Chart 10: Annual Pro-forma Debt-EBITDA ratios of European LBOs

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Outlook – recovery set to gather paceThe first half of this year has seen an uptick in new LBO activity with ten deals a quarter compared to ten in second half of last year. Whilst this is encouraging, it is the lowest run rate since the late 1990s.

In our view, loan volumes are being held back by a lack of M&A activity than availability of finance.

Indeed, the strengthening of leveraged finance teams at the major investment banks, activity in the high yield market and the increase in fund activity, all suggest this is more a demand than a supply side issue.

Our own M&A order book is significantly higher than a year ago and we would expect a general improvement in animal spirits to lift leveraged finance volumes over the next twelve months.


Given the increasing capacity and depth in the European leveraged finance market, • there is scope for prospective borrowers to be more demanding, not just in terms of price but also with regard to debt multiples and tenors.

When considering to raise new financing, borrowers should take into consideration • the full range of sources available to them, which may include commercial banks, specialized debt funds, bank loan mutual funds, mezzanine funds, asset-backed loan (ABL) providers and various capital markets.


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In Q2 2010 only five companies incurred a payment default or entered into formal negotiations compared to thirty in the same period a year ago.

However, the number of requests to reset financial covenants has declined less sharply. This is evidence that the severity of new cases is lessening.

Chart 11: Restructuring trends

Source: S&P LCD

Restructuring: Lenders continue to take a robust approach, but the number of new cases declines significantly

Key trends

The number of European corporate borrowers incurring a payment default or entering into formal restructuring discussions fell to just five in Q2 compared to thirty a year ago. This continued the trend established in Q3 2009 and mirrors our own experience over the last six months. The number of requests to reset covenant has also declined over the last year, although not as sharply.

Restructurings continue to result in a wide range of outcomes for shareholders and creditors. Of twenty-one deals agreed in the last nine months across Western Europe (principally syndicated leveraged buyouts), shareholders maintained control in eleven (always through the provision of some new money), senior lenders took control in nine and mezzanine lenders led a recapitalisation in one; none went into a classic fire sale administration. The outcome is often determined by where value breaks in the capital structure, but the jurisdiction of the borrower can also have a material influence on the shape of a deal.

Increased levels of debt trading in the secondary markets - which can introduce a variety of different lenders with different agendas and objectives to the original debt syndicate – have also complicated the outcome in recent cases we have been involed in.

At the less stressed end of the spectrum a number of borrowers have raised high yield bonds, new leveraged loans (Heidleberg Cement, Ardagh Glass) or extended loans (Yell, ONO) to deal with nearer term maturities.

Debt defaults decline With economic conditions slowly improving the number of European corporate borrowers defaulting on debt repayments or entering formal restructuring discussions continued to fall in the second quarter of 2010. This continued the trend established in Q3 2009 and is supported by our own experience over the last six months.

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The balance of outcomes in a restructuring between shareholders and creditors continues to be mixed. Of a sample of 21 deals (mainly syndicated leveraged buyouts) agreed over the last nine months in Western Europe involving new money or a debt writedown, shareholders maintained control in eleven, senior lenders took control in nine and mezzanine lenders led the recapitalisation in one (Gala Coral). The outcome is influenced by where the value breaks in the capital structure, but is also impacted by the legal jurisdiction of the borrower with some European jurisdictions being more debtor friendly than others. M&A has not often been part of the solution with only two deals in our sample being lined up for a rapid sale process post restructuring (neither of which has yet to complete). Where equity is willing to continue to support a deal, mezzanine lenders have largely been protected, albeit at times having to convert to an all PIK instrument as part of the overall deal economics.

The fact mezzanine has only led one recapitalisation in our sample reflects, in our experience, a lack of funds to commit to distressed situations, but also their relatively thin strip of the capital structure (typically they are either significantly out of the money or equity still has an incentive to invest).

Private equity-backed businesses, even those which have been through the wars, are generally highly cash generative and underneath the debt there is usually a solid business. While the debt might need to be radically restructured, it is relatively uncommon for an LBO business of any size to go into an uncontrolled insolvency.

Secondary trading complicates the pictureRecent months have seen a significant increase in secondary debt trading in restructuring credits. While the focus tends to be on larger,

more liquid credits, bilateral trades on smaller deals also take place. As the market has returned and pricing has increased, secondary debt trading is now no longer such an unattractive exit route for the bank lenders.

Buyers of distressed debt are typically hedge funds. Depending on their own investment philosophy and the nature of the particular credit, hedge funds can pursue a range of different strategies ranging from very active to relatively passive and with short-term or long-term objectives.

The entry of hedge funds into a deal can have both positive and negative consequences for the borrower. Hedge funds are looking to deploy capital in distressed situations and can therefore form part of the solution if there is a new money requirement. Recently, we were involved in a deal where hedge funds offered to underwrite an equity injection several hundred million pounds higher than that proposed by the shareholder. Hedge funds are also more willing to accept a greater amount of de-leveraging than other lenders as part of a restructuring so that the agreed solution is closer to a long-term fix than a sticking plaster.

However the price of hedge fund support is typically more expensive debt (with non-call periods to lock in the uplifted remuneration) and a desire to take a significant or controlling equity stake.

The negotiation process also becomes significantly more complicated with the introduction of hedge funds into a deal. Terms that have been provisionally negotiated with lenders (in some cases over months) can be disregarded and funds can change their asks rapidly as their understanding of the situation increases (because, in some cases, they buy into positions with relatively limited prior knowledge).

Restructuring: Lenders continue to take a robust approach, but the number of new cases declines significantly (continued)


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Pricing and covenantsRestructuring facilities typically involve a margin increase in the region of 100bps since lenders will tend not to re-price to terms that would be available on a new deal.

Average amendment fees on recent European deals are c. 65bps. In our experience, amendment fees, typically range from 50bps to 100bps depending on the complexity of the ask.

Chart 12: Average margins on LBO facilities Chart 13: Average amendment fee

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Outlook In the near-term, we do not expect a sharp uptick in restructurings. Indeed, one large UK lender indicated to us recently that they were not expecting a significant inflow of cases until next year.

The opening up of the high yield bond and leveraged loan markets is also enabling borrowers to tackle their upcoming maturities. This has chipped away at the oft talked about maturity cliff. Figures from S&P show that outstanding 2012 leveraged bullet maturities have fallen by 50 per cent since December 2008 and 2013 maturities by 17%. However, this still leaves the bulk of the wall in 2014/2015 to work through. Indeed, S&P LCD estimates that 45 per cent of deals in their loan index in December 2008 (250 borrowers) are still in their original form (ie no refinancing or restructuring) as of May 2010.

These credits will experience tightening covenants over the life-time of a deal so borrowers that have managed to trade through the recession may still face pressure over the next 18 months, particularly if the recovery stumbles into the much-feared ‘double-dip’.

In addition, borrowers that have restructured their facilities are still likely to be relatively highly-geared. A couple of restructurings we have been involved in recently involved opening leverage of 8.0x and 10.0x respectively. These deals are predicated on significant turnarounds in EBITDA, which may not materialise necessitating a further round of restructuring in due course. In this vein, Crest Nicholson is reported as being valued at c.£350m - £500m in contrast to its restructred debt level of £620m.

For these reasons, we believe the next few years are still likely to involve a significant number of work outs, particularly in the LBO space.

Alongside LBOs where most of the debt maturity concerns lie, the other potentially difficult sector is property where five-year bullets are beginning to mature. However, we have seen some willingness to extend maturities on property deals if the assets concerned can continue to service the loans attached to them.

Chart 14: Loan maturities - European institutional debt

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Borrowers must monitor debt • covenants carefully and approach lenders significantly before any anticipated covenant breach. Although this is unlikely to achieve much of a pricing benefit, it will give lenders enough time to work through the process – which may require due diligence – prior to the breach actually occurring.

The secondary debt market can • offer borrowers or shareholders the opportunity to buy-back a company’s debt at a discount. As well as being a cost-efficient way to de-leverage, a buy-back can also be used to reduce the risk of a financial covenant breach or enable a shareholder to influence the outcome of debt negotiations.

The opening up of the high yield and • leveraged loan markets offers options for mid sized to larger corporates to tackle upcoming debt maturities.


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Our Debt Advisory services: How we can help you

Securing committed facilities has never been more criticalWhether you face a covenant breach, need to restructure existing facilities, have facilities due for refinancing over the next 24 months, or are considering raising debt to finance an acquisition, we have an experienced team to help you achieve your financing objectives.

We are in regular contact with 50+ banks, debt funds, asset based lenders, credit agencies and bond arrangers and can assist you in:

maintaining control of the agenda in a debt restructuring, through our detailed knowledge of • the approach lenders are taking in this rapidly changing market;

negotiating better terms and conditions;•

advising on the appropriate debt capacity and structure in the current market in addition to the • likely pricing for your transaction;

identifying and approaching lenders which are still active in your sector;•

evaluating your business plan and testing your financial models to help to ensure they are • robust; and

credit ratings advisory / improvement of credit ratings.•

Managing the process from start to end, allowing you to focus on running your business


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Our Debt Advisory team provides an extensive range of services which include:

What we do

Facilitate ongoing • funding for the company

Investigate • alternative sources of funding

Aim to optimise • finance costs

Assessment of • optimal capital structure

Restructure debt to • help avoid financial distress: structure, sources and timing

Analysis of • forecasts to support new covenant proposal

Negotiate pricing, • covenants and other terms with lenders

Increase competitive • position of client by securing funding

Assist in • negotiating pricing, documentation and setting covenants

Assessment of • optimal capital structure

Restructure debt to • help avoid financial distress: structure, sources and timing

Debt discovery • exercise to confirm market appetite

Underpins price • expectations

Refinancing

Financial/debt restructuring

Covenant negotiation

Acquisition finance

Bond market advisory

Staple financing


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UK May 09

Financial restructuring

Total Debt

£900m

UK Apr 09

Refinancing

Total Debt

£40m

Selected recent transactions

UK Aug 09

Staple debt finance

Total Debt

£75m

UK Aug 09


Total Debt

£430m

Europe Jul 09

ABL acquisition finance

Total Debt

€45m

UK Jun 10

Total Debt

£750m

UK Mar 09

Refinancing

Total Debt

£200m Public Bond

UK Aug 09

Debt restructuring

Total Debt

£900m

UK Aug 09

8.375% Senior secured notes

Total Debt

£250m & $425m

UK Jan 10

10.625% secured notes

Total Debt

£785m

KERLING PLC

UK Mar 10

9.625% senior notes

Total Debt

£225m

UK Jul 09

Debt restructuring

Total Debt

£700m

UK/US May 10


Total Debt

$300m

Europe Nov 09

Debt restructuring for metals producer

Total Debt

€15bn

Germany Ongoing


Orion Cable

Total Debt

€950m

Europe Ongoing

Restructuring of Coeur Defence, Paris

Total Debt

€1.6bn bonds

Switzerland July 10


Total Debt

CHF2,500m

UK Mar 10

Refinancing

Total Debt

$590m


Hotels group


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For further information, except for US residents enquiring about corporate finance related services, please contact:

LondonSimon Boadle Partner, Head of Debt Advisory +44 20 7212 4118 [email protected] Berkowitch Partner +44 20 7213 1429 [email protected] Green Partner +44 20 7212 2535 [email protected] Ambrose Director +44 20 7804 0737 [email protected] Kole Director +44 20 7212 3650 [email protected] Tilbrook Director +44 20 7212 4773 [email protected] Turner Director +44 20 7804 7823 [email protected] Choudhary Assistant Director +44 20 7212 2343 [email protected] Fieldhouse Assistant Director +44 20 7212 1425 [email protected] Naydenov Assistant Director +44 20 7804 9542 [email protected] Pradhan Assistant Director +44 20 7213 3231 [email protected] Rusche Assistant Director +44 20 7804 5610 [email protected]

NorthColin Gillespie Partner +44 161 245 2404 [email protected] Warriner Partner +44 113 289 4514 [email protected]

MidlandsMatt Waddell Partner +44 121 232 2224 [email protected] Worrall Partner +44 121 265 5709 [email protected] Skinner Director +44 121 265 5591 [email protected]

ScotlandDavid Leslie Partner +44 141 355 4122 [email protected] Miller Director +44 141 355 4123 [email protected] O’Connor Manager +44 141 355 4127 [email protected]

SouthJon Harrison Partner +44 1293 56 6770 [email protected] Morgan Partner +44 118 938 3191 [email protected] Partridge Director +44 29 2080 2277 gary.partridge @uk.pwc.com

Capital MarketsClare McDowall Partner +44 20 7213 3964 [email protected] Hawthorne Director +44 20 7804 9881 [email protected] Millar Manager +44 20 7213 3545 [email protected]

AustraliaMichael Branson Executive Director +61 (2) 8266 3279 [email protected] Santoro Executive Director +61 (3) 8603 4707 [email protected]

Contacts

For more information visit our website at:

pwc.co.uk/cf

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This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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Documents

4 Debt Markets Update - PwC UK€¦ · Debt Advisory – Debt Markets Update Summer 2010 1 4 Introduction 4 Spotlight - Asian Debt Markets 4 Corporate Lending 4 Corporate Bonds 4