PRODUCTS EXPANDED DEBT CAPACITY Affordability Products Amsterdam Institute
PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products) Amsterdam Institute of Finance Joseph V. Rizzi December, 2015
Expanding Debt Capacity Rising purchase price multiples and ROE concerns drove acquirers to seek ways to expand their debt capacity. Some of the most common techniques are: Adjusted (Increased) EBITDA - Operating improvements - Normalization Asset Sales - Bridges to asset sales - Liquidity is key in case bridge cannot be taken out Innovative Securities - Defer interest - Push out amortization - Increase flexibility Amsterdam Institute of Finance December, 2015 2
Debt Options 1 L Term Amortization Covenant Call Seniority Secured Revolver 5– 7 Bullet FULL YES YES Term Loan A 5– 7 40% in first 5 years FULL YES YES Institutional Term Loans 7 -8 1% per annum / bullet FULL YES YES Covenant Lite 8 - 10 1% per annum / Bullet LIGHT YES YES Mezzanine 10 + Bullet LIGHT PREMIUM NO Depends High Yield 10 + Bullet LIGHT PREMIUM NO&YES NO Holding Company PIK 10 + Bullet LIGHT PREMIUM NO NO Bridge Term Loans 1 -3 Bullet FULL YES YES Second Lien 8 -9 Bullet FULL YES YES Bullet Yes Yes Unitranche Unsecured 1 -10 1% P. A. /Bullet Yes Yes No OPCO/PROPCO 10+ Bullet Yes Yes The above table shows the features of different debt options available to issuers The availability of the different options is subject to market conditions Amsterdam Institute of Finance December, 2015 3
Relative Value Over the last twelve months, the CS High Yield Index returned -2. 18%, the CS Leveraged Loan Index returned 0. 81%, and the S&P 500 returned 10. 51%. The FTSE NAREIT All REITs were the best performer of the major asset classes, with a 11. 16% return. Amsterdam Institute of Finance December, 2015 4
Sponsor Based Debt Financing Allocations and Capital Providers of Capital Institutional Investors Banks, Commercial Banks, Securities Firms Hedge, Mutual, Pension Funds CLOs 1 L Capital Structure Facilities Revolving Credit Facility Term A Loan (Tla) Leveraged Loans – Pro Rata Tranche --------------Leveraged Loans – Pro Loans Rata Tranche Asset Backed ------------------------- Insurance Companies 2 L Special Purpose Facilities (e. g. , Acquisition Line Term B Loan (TLb) Others (e. g. , Financing Companies) (BDO) Second Lien Private Debt Funds Equity Other Debt High Yield Bonds (incl) PIK Mezzanine Unitranche Private Equity Funds and Co-Investors Warrants Preferred Equity Common Equity Leveraged Loans. Institutional Tranche Senior (Including Cov – Lite) Junior Debt Equity Based on amended HBS case exhibit Amsterdam Institute of Finance December, 2015 5
Complex Corporate Structure Equity #1 Equity #2 European Holding Company #1 European Holding Company #2 Preferred Stock NEWCO High Yield/Sub Notes Bank Deal with Upstream Guarantee Collapsed After Closing Local Target Guarantee Due to the structural nature of Subordination in Europe, bank Debt would be placed at the Operating subsidiary level. Domestic Operating Subsidiary Foreign Operating Subsidiary* * Tax limitations surrounding guarantees from foreign subs. Amsterdam Institute of Finance December, 2015 6
Innovative Securities and Relative Value Considerations Innovative securities allow for the expansion of debt capacity by one or more of the following mechanisms: Reduce Annual Debt Service - Reducing cash interest expense - Lengthen duration (Reduce/Delay amortization) Increasing Flexibility - Covenants - Cash flow control - Bridging - Public Disclosure - Call Premium - Partial/fully Unsecured Tranching (sequential ordering of payment or priorities) – A/S - Holding Company instruments - Restricted Subsidiaries - Second lien/bifurcated collateral-crossing liens - Senior/Subordinated Cost – Second Lien vs Mez Amsterdam Institute of Finance December, 2015 7
LBO Transaction Structures Jan-Sep 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 Senior Senior Only 75% 55% 65% 60% 75% 20% 25% +2 L 15% 20% 10% 5% 5% 5% 10% +Mez 5% 5% 10% 20% 25% 65% 15% 40% +2 L+Mez 10% 30% 25% +HYB 10% 20% 30% 20% 20% Source: S&P Capital IQ Amsterdam Institute of Finance December, 2015 8
Non Investment Grade Loan Market Bank Oriented Revolver T/LA Institutional Investor T/LB 2 L Regulatory Leverage “Test”: <6 X EBITDA Decreased Volume Less issuance as strategic acquirers crowd-out PE Amsterdam Institute of Finance December, 2015 9
New Western European Leveraged Loan Syndications Monthly Volume Amsterdam Institute of Finance December, 2015 10
Average Price of the Credit Suisse Western European Leveraged Loan Index Amsterdam Institute of Finance December, 2015 11
Western European Leveraged Loan Market Size: Institutional, TLAs and Bank-held Facilities Amsterdam Institute of Finance December, 2015 12
Second Lien Loans Senior Secured, but with Junior or Second Lien-Lower recovery Competing with EURO Mezzanine ◦ Investors – hedge funds and CLO Spread differential between Second Lien and First Lien currently around 325 BP Volume: U. S. EUR 9 Mos 2015 $10 B $. 6 B Issues: - Inter-creditor - Standstill Agreement - Obligations - New Investors Behavior in a Workout bought at discount - CLO Rating Impact % limit on 2 L paper Amsterdam Institute of Finance December, 2015 13
Unitranche Hybrid Senior/Mezzanine/2 L Combination Separate Revolver: Usually Banks with an Inter-Creditor Agreement Unitranche Term Position: Alternative nonbank providers Middle Market Oriented Bank Risk Appetite Supplement Size: Usually <€ 150 mln First Appeared in 2005. Increased Popularity Following Crisis When 2 L and CLO Stalled Blended Rate: Target Returns Around 7% PIK Portion Amsterdam Institute of Finance December, 2015 14
Covenant Lite Covenant Issues ◦ Creditor – preserve deal; recovery value ◦ Debtor – flexibility Covenant Lite – liquidity vs. structure ◦ Similar to Investment Grade ◦ One or No Financial Covenants Rating Agency impact on CLO Volume ◦ US – Now dominant form >90% ◦ Europe – Majority of new issuance >45% Almost no incremental yield over first lien loans with financial covenants Amsterdam Institute of Finance December, 2015 15
‘Op. Co Prop. Co’ Financing (1) By structuring the financing of a pool of assets with a credit quality stronger than the corporate credit as a whole, ‘Op. Co’ ‘Prop. Co’ financing can provide a cost effective source of (acquisition) financing. Example: ◦ Target company de-merged into ‘Prop. Co’, which owns the real estate assets, and ‘Op. Co’, the operating company. ◦ Banks finance ‘Prop. Co’ acquisition of properties at agreed Loan to Value ratio. ◦ ‘Prop. Co’ leases the real estate assets to ‘Op. Co’. ◦ ‘Prop. Co’ debt refinanced by traditional Property Lenders or via Commercial Mortgage Backed Securities (CMBS) market. ◦ ‘Op. Co’ required to service the acquisition debt not assumed by ‘Prop. Co’. REIT Amsterdam Institute of Finance December, 2015 16
‘Op. Co Prop. Co’ Financing (2) Bid. Co Financing Approx. 100% Notes Approx. 100% Op. Co Prop. Co Rental Payments Amsterdam Institute of Finance December, 2015 17
High Yield Bonds • Longer Term Bonds q 7 -10 years and longer q 4/5 NC • Public or Private q q Usually issued in private form with exchange rights Pricing would step up if bonds not public within short period (say 180 days of close) • HYB New Issue (€ B) 9 mo 2015 2014 2013 2012 2011 2010 2009 2008 2007 Market Size Amsterdam Institute of Finance December, 2015 U. S. ($) 200 240 260 170 220 120 45 100 1. 5 T Europe (€) 60 75 75 40 35 40 20 20 470 B 18
Key High Yield Terms • Registration rights • Issuer • Status • Degree of subordination • Limitations on liens • Limitations on indebtedness • Restricted payments • Asset sales • Change in control • Minimal financial maintenance covenants Amsterdam Institute of Finance December, 2015 19
European Mezzanine Terms (Currently dead due to HYB, 2 L and Unitranche loan competition) Covenants * * Extensive (bank type) Maintenance basis (tested quarterly) Security * Second secured Call Provisions * Generally callable immediately (103, 102, 101) Maturity * Ten year Pricing * * * LIBOR + Warrants for total return TBD Liquidity * Low Disclosure * Limited Marketing * No research coverage, no roadshow Rating Requirements * None Amsterdam Institute of Finance December, 2015 20
PIK • Pay if you can toggle • Ratings – NR or CCC • Eats up equity • Holding Company Issuer • Characteristics Amsterdam Institute of Finance December, 2015 Spread 825/900 Toggle 900 -1000 Term 7. 5 -10 Call 5 x. NC Leverage 6. 5 x+ 21
Stapled Financing Staple financing term sheet to deal book Be prepared to fund Establishes ceiling Conflicts of interest Amsterdam Institute of Finance December, 2015 22
ACCORDIAN LOAN Incremental Loan Facilities • • Option allowing increase in principal under existing terms subject to certain conditions Existing lenders can participate or new lenders can be sought Dilution of Lender Interest • • Uncommitted – access requires lenders willing to provide Suffer dilution if you elect not to participate and facility approved Amsterdam Institute of Finance December, 2015 23
Bridge Loans Equity ◦ Bank provides equity Find other equity investors later or keep Reduce PE equity Lowers need for club or larger deals ◦ Rationale – pay to play ◦ Bonds Amsterdam Institute of Finance December, 2015 24
Changing Nature of Leveraged Finance Capital Structures Increasing layers of debt Directed at different investors Intercreditors conflicts 2012 - Present • Common equity • Hybrid preferred (0. 5 x) 2004 + 2 H 07 - 2011 • Common equity • Unsecured/mezzanine (1 x) • Senior secured bank loan (4 x) - Amortizing T/LA – 40% - B tranches – 60% FDX – 5 x + PPX – 7. 5 + Amsterdam Institute of Finance December, 2015 • PIK notes (0. 5 x) • Unsecured/mezzanine (1 x) • Carve-out collateral (1 x) - OPCO/PROPCO • Second lien loans (1 x) • Senior secured bank loan (4 x) - Amortizing T/LA – 20% - B tranches – 80% FDX – 6 x + PPX – 9 + 25
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