A Swing Line for Swingline

In November 2011, ACCO Brands, a leading manufacturer of office products, and MeadWestvaco Corporation, a leader in packaging, agreed to merge MeadWestvaco’s Consumer & Office Products business into ACCO Brands in a transaction valued at approximately $860 million. The deal, which closed in May 2012, gave MeadWestvaco shareholders 50.5% of the combined company.  Among the company’s many products are Kensington computer accessories, Mead school supplies, and Swingline Staplers. As part of the transaction, ACCO refinanced virtually all of its existing debt.  The new capital structure included $500 million of high yield bonds and over $750 million of term loans.  In addition, the company obtained two revolving credit facilities: $200 million U.S. dollar, and $50 million multi-currency. Let’s take a look at the $200 million U.S. dollar revolver.  It has commitments from 16 banks, ranging from about $4 million to about $20 million (i.e. 2% to 10% of the total facility) and was expected to be used for general liquidity needs and letters of credit.  If the company has a financing need, say $100 million for 6 months, it sends a borrowing notice to the administrative agent, in this case Barclays, who sends a notice to the other 15 banks, who all advance their proportionate share of the total borrowing.  This process happens for hundreds of syndicated revolvers every day. But what if the borrowing need isn’t $100 million for 6 months, and is, instead, $10 million for 6 days?  The process could work the same as for the larger, longer need, but that would mean that the bank with the smallest commitment, in this case Deutsche Bank, would have...

How Much Can I Borrow on My Revolver?

We often tell our clients that a company does not file for bankruptcy on a particular day because it has too much leverage, or because it has a bad management team, or because it has a competitive disadvantage.  All of these factors may eventually drive a company out of business, but the reason a company files for bankruptcy on a particular day is liquidity: they run out of cash.  Therefore, it is important to measure a company’s liquidity as part of any comprehensive financial analysis (one of our favorite tools is the liquidity position). For many companies, availability under a committed, revolving line of credit is a key source of liquidity. Here’s an example: In 2010, Sears Canada entered into a five-year $800 million senior secured revolving credit facility.  As of January 28, 2012, they had borrowed $101 million under that facility.  How much additional can they borrow using that revolver? a) $699 million b) zero c) Something between $699 and zero The answer is … you don’t have enough information to give an answer.  According to Sears, they have $415 million available. Here are the factors that determine how much you can borrow on a revolver: How much you have already borrowed.  In the Sears example, it would reduce availability to $699 million Letter of Credit usage.  Many revolvers can also be used for letters of credit.  This allows companies to issue letters of credit without getting credit approval for each one individually.  However, letters of credit issued under a revolver reduce borrowing availability under that revolver.  In the Sears example, they had approximately $284 million of letters...

Does anyone out there need a loan?

We stumbled upon these striking charts in an article in the Financial Times recently. It has interesting implications for credit analysis. The last decade’s boom in credit has been remarkable, led, of course, by mortgage-backed securities. But debt funding by companies is a close second, if you count “corporates” and “money-markets.” There are plenty of reasons to believe the surge in corporate debt will continue. Equity’s miserable performance over the last ten years makes it much more expensive than debt, for one thing. And businesses in developing economies are hungry for capital, for another. Although the article focuses on trading opportunities, debt markets move on a couple of drivers: technicals like changing interest rates and fundamentals like credit quality. After the market seizures of 2008, portfolio managers  can’t be so confident they can trade their way out of a poor credit position. That means strong demand for credit analysis at origination and in the after-market. Corporate loan and bond portfolios did not take the same drubbing as the mortgage-backed markets over the last several years, but doesn’t mean they were risk-free. At the worst, the global default rate on investment-grade bonds was 5.4% in 2009, and on non-investment grade bonds it was 13.0%.  Commercial loan delinquencies in the United States were at a 4.5% rate at the end of 2009. The debt markets got a memorable course of risk-aversion therapy recently, and they’re likely to remain acutely risk-conscious for some time. Regulators doubtless will be especially vigilant about credit risk as well. Banks, investors, and traders who take credit risk will want to pay close attention to the fundamentals....

Amend and Extend or Amend and Pretend?

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...

We’re All Cash Flow Lenders Now

Loans to non-investment grade and middle-market companies are typically secured by the borrower’s receivables, inventory, and fixed assets. Pledging this collateral, however, does not reduce the borrower’s likelihood of default. Security should reduce the loan’s loss given default, but not necessarily in the way you expect. Here’s how. How Are Loans Repaid? Banks that make secured loans do not expect to foreclose on the collateral to repay the loans. Loans are typically repaid from cash flow from operations or by refinancing with new debt. Foreclosing on collateral is a last resort. Some lenders, such as those that provide asset based loans, equipment finance, or mortgages, are expert in disposing of foreclosed assets, but most banks are ill-prepared to seize assets and sell them. So Why Take Collateral? Most secured lenders to bankrupt large corporate and middle-market companies never take possession of their collateral. Instead, the companies are reorganized or sold using the bankruptcy system (e.g. Chapter 11 or Chapter 7 in the U.S.). Proceeds from the bankruptcy, either cash or new securities, are then distributed to creditors. Secured creditors have a higher priority when these proceeds are distributed, giving them lower losses than unsecured creditors. Does Collateral Mean the Loan Will Be Repaid? Unfortunately not. Even if the value of the collateral exceeds the amount of the loan when it is made, it is likely that the value of the pledged assets will be substantially lower when the borrower is in financial distress. After all, an asset is only worth what someone will pay for it, and, as we’ve seen, many assets decline in value in a recession. What’s...