Climbing the wall

It’s quite a number: no less than $46 trillion debt needs to be refinanced in the space of just five years, according to rating agency Standard & Poor’s. European companies in particular may face serious challenges dealing with this wall of maturing debt, a wall so high that it could leave a midden of insolvencies and defaults, with follow-on implications for the banks that issued that debt.
When law firm Clifford Chance published its ‘scaling the refinancing wall’ report last year, warning that sponsors and shareholders may “face the prospect of owning distressed assets and cash sweeps, or worse, creditor restructuring or enforcement,” and that “creditors, who may be seeking to reduce their balance sheet or recycle capital, may end up trapped in legacy financings long after the anticipated refinancing date,” the market was already in jitters.

The debate intensified in the UK in March this year when the Bank of England released a report arguing the “fragility of the corporate sector” that has resulted from the leveraged buyout boom of the early 2000s could spark a new financial crisis in the event of widespread defaults and ultimately impact “the resilience of the financial system”. Private equity-owned businesses in the UK are currently servicing £160 billion (€173 billion; $224 billion) of debt, £32 billion of which will need to be refinanced by 2015, according to BofE figures.

What helps to calm nerves is that the market appears to have recovered. The first quarter of 2013 was the busiest for CLO issuance in the US since 2007, with $60 billion raised, according to data from JPMorgan Chase. Figures published by S&P show that global loan issuance in the first two months of the year jumped by 85 percent to $119 billion compared to the same period last year. The European market also saw three new CLOs being raised recently; market participants say there are others in the pipeline.

“To the discerning commentator, there’s a lot more to the story,” explains Mark Vickers, partner at law firm Ashurst in London.

“Various strands of influence are coming together – the large deals that were completed in 2006 and 2007 may be coming to the end
of their contractual life, but market liquidity is extremely buoyant in both high yield and loan issuance.”

Heavily indebted European companies were able to limp through 2012 largely unscathed. “Thanks to increased liquidity in the debt markets, and political measures to shore up the euro, restoring some confidence,” says Philip Davidson, global head of restructuring at KPMG. He believes that the maturities that were hit have effectively been absorbed by capital markets. “For well-regarded companies, debt in need of refinancing is moving fast as loans are extended and maturities pushed out. We are not quite seeing pre-2007 deal metrics as they are in the US but it could be coming.”


Extend, amend, pretend 

As a result of the increasing volume of primary deal flow, pricing for new debt has been under pressure. This has substantially increased the perceived attractiveness of ‘amend and extend’ negotiations, as lenders warm to the idea of receiving enhanced yield in return for the extension of maturities. According to Fitch Ratings, amend and extend deals completed in Europe since the fourth quarter of 2010 now exceed €70 billion.

Last year alone saw more than 20 large-cap ‘amend and extend’ requests that were ultimately approved in Europe, according to figures by debt advisory firm Marlborough Partners. “Large, sponsor owned companies with CLO heavy syndicates have found it relatively easy to negotiate extensions as a quid pro quo of giving additional economics to investors,” explains David Parker, a managing partner at Marlborough Partners. “Banks are returning to a risk-on mentality, also they would rather negotiate terms than participate in write-offs that deteriorate the value of the loan.”

But not every credit is right for the treatment. According to Fitch Ratings, 23 percent of the maturing loans in Europe carry ‘B-’ or below ratings. With banks facing tighter capital adequacy requirements, this non-investment grade debt cannot always be extended.

“Amend and extends have in recent years been the last resort solution for refinancing, but it becomes much more difficult when a company is vulnerable from a credit point of view,” explains S&P’s Watters. He believes that the senior lenders for the most at-risk issuers experiencing covenant issues will typically require new equity from the shareholders before countenancing an extension of maturities via an amend and extend. “The presence of out-of-the money subordinated lenders, which is the case for 70 percent of the ‘B-’ or lower rated entities, may lead to more defaults and the restructuring of balance sheets to achieve deleveraging,” adds Watters.

These difficulties notwithstanding, many European companies are taking advantage of the refinancing opportunities in the market. Matthew Sabben-Clare, partner at private equity firm Cinven in London, says the refinancing market has had a strong start to 2013 with high yield bond issuance peaking alongside leveraged loan issuance. He adds: “European banks have also generally proved to be supportive in giving a long runway to leveraged companies, preferring to avoid crystallising defaults.”

Sabben-Clare also points out that Europe’s largest buyout firms have refinanced more than €25 billion in leveraged debt so far in 2013 amid the most favourable debt market conditions seen since the market collapsed in 2007. “The larger sponsor-backed companies have largely been able to refinance more easily than the smaller companies who are relying on a different category of investors, i.e. the banks.”

Needless to say that private equity firms like Cinven have been active in monitoring their portfolios. “You have to be proactive when it comes to refinancing,” says Sabben-Clare. “We’ve had six amend and extends, and we’ve also issued five high yield bonds. The debt in need of refinancing is being dealt with as loans are extended and maturities pushed out, and in some cases companies have been able to gain increased covenant flexibility,” he adds.


The high yield road to rescue

Cinven’s ability to source fresh funding in the high yield market is also part of a wider trend. Increasingly, borrowers who are unable to reach agreements with creditors are offering public and private bonds to take advantage of the surge in demand for high yield.
“Effectively, high yield bonds are now the ‘get out of jail card’ for many companies,” one debt fund manager tells Private Debt Investor. “The refinancing wall has encouraged many companies to reduce their reliance on bank loans.”

In the US, where high yield has long been a deep and widely tapped market, 2012 saw $46.8 billion issuance of bonds – the biggest volume since 2003. According to PwC, the equivalent figure for 2013 will be $60 billion.

Ciara O’Neill, a managing director at DC Advisory, notes its popularity with European borrowers. “The sheer depth of US institutional liquidity and the resulting tight pricing, is making the US market attractive for European borrowers, with some institutions even factoring in $/€ swap costs investors benchmark pricing against public bonds issued in the US markets.”

While US high yield accounts for about 70 percent of all refinancing, in Europe its share is closer to 30 percent. “In Europe it is the complete opposite,” says Ashurst’s Vickers. “The transatlantic finance markets have evolved differently but what we are continually seeing is Europe migrating to the US style.”

Vickers is one of many observers predicting that Europe’s bond markets will soon provide a greater portion of the funding needed for refinancing.

“Conditions which were generally challenging for high yield issuers 18-24 months ago have steadily improved. European high yield issuance in the first quarter of this year was more than half the annual total for 2012. As for terms, call periods are shortening and portability is becoming increasingly common,” adds Vickers.

Recent users of the market include French medical diagnostics company Labco, which issued a €100 million bond at the start of the year, while Charterhouse Capital Partners issued a high yield bond to refinance
£1 billion of its private equity portfolio.


Whither distressed funds?

The refinancing market is selective and often takes a dim view of high risk credits. As a result, there are those transactions that have not yet made strong progress in deleveraging, or have already refinanced once without delivering a more permanent exit for lenders.

For some investors such as hedge funds, these more challenging assets provide an interesting opportunity in their own right. KPMG estimates that more than €300 billion has been raised that is targeting predominantly European companies struggling with refinancing. The task facing the managers of these distressed pools is to work where and how to deploy it all.

“A year ago, all these distressed funds were coming into the market, and have been waiting for distressed opportunities to be triggered,” says Elvire Perrin, partner at investment advisor and fund of funds manager Altius Associates. “It simply hasn’t been triggered, and the market has shown that there is almost a decline in what market participants had anticipated, as most of the loan maturities due this year were able to refinance.”

KPMG’s Davidson also notes that the distressed opportunity isn’t as compelling as some might think. “There is an oversupply of funding trying to cater to this market,” according to KPMG’s Davidson. “Notwithstanding the unattractiveness of some companies to existing lenders, there is often unwillingness on both sides to break the compact for fear of higher costs or crystallised losses.”

In the final analysis, the ongoing shift from reliance on traditional bank loans to a more diversified range of funding options has increased the options available to borrowers. Given the regulatory initiatives that are driving Europe’s adoption of a more capital markets-based system similar that the one in the US, this change is likely to be permanent.

What matters in the short-term is whether there can be pricing and credit equilibrium between lender and borrower, concludes Ashurst’s Vickers. “The pools of liquidity are much more diverse than they were 18-24 months ago – including a rampant high yield bond market, a resurgent European CLO market and the emergence of credit funds. Market innovation is finding funding solutions for many situations, but inevitably it will not come to the rescue of all.”


Refinancing infrastructure debt

Regulatory pressures coupled with macroeconomic uncertainties have led banks to “reinvent themselves from long-term facilitators to short-term creditors,” says Michael Wilkins, managing director of S&P’s infrastructure finance unit. “There is a general reluctance from banks to lend on long-term projects of anything beyond seven years.”

Wilkins argues that the withdrawal of bank funding for long-term infrastructure projects has given rise to considerable appetite from insurance companies and pension funds eager to fill the hole.

Sergio Ronga, head of debt refinancing infrastructure projects at DC Advisory, believes the financial crisis raised sponsors’ awareness and sensitivity to liquidity and volatility in the debt markets, and as a result a number of assets refinanced the underlying debt well ahead of maturity.

Ronga highlights that active bond markets have assisted with this process in recent years, as bank debt funding was replaced with bond funding at the time of refinancing. “Bond funding also allows borrowers to raise longer-term debt tranches, often rated strong investment grade by the rating agencies,” he adds.


A SAUR deal

SAUR, France’s third-largest water company, is playing host to the country’s great infrastructure drama.

Counting AXA PE, Cube Infrastructure, French sovereign wealth fund FSI, and Seche Environnement (Seche) as shareholders, SAUR has become a cautionary tale of what can happen to a good asset when you load it with too much debt and, crucially, when shareholders pull in different directions.

Seche, SAUR’s second-biggest shareholder, embarked on a failed takeover of the water utility against fierce opposition from the firm’s other shareholders, which feared the takeover would trigger a refinancing of SAUR’s c.€2 billion debt pile.

The bickering got so bad it eventually paralysed the company, triggering a debt restructuring process that has seen SAUR recently receive three takeover / refinancing offers .The end result: the company is now worth at the most half of its €2 billion-plus acquisition value, equity shareholders are facing a wipeout, and the creditors a massive writedown.

Mathias Burghardt, head of infrastructure at AXA PE, is philosophical about SAUR.

“One of the mistakes [made] in the market was to use too much leverage. A few years ago, we almost had to fight [off banks] to refuse leverage for our transactions. The asset is actually quite good, but when you have too much leverage, even a good asset turns bad. That’s one of the lessons the industry has learned,” he argues.

He continues: “That investment also corresponded with a pretty violent turning in the cycle. Not all investments in infrastructure have gone well and, as a consequence, a lot of the bigger players have disappeared or scaled down significantly.”


The real estate angle

The task of refinancing a real estate asset is similar to reworking the balance sheet of a corporate credit. “Both examine the value of the underlying asset and stability of cash flows. However for real estate lending it is about the property and the tenants, whereas in private equity-owned companies it is more about the operating performance, growth prospects, and net assets of the company,” explains Gareck Wilson, head of real estate refinancing at real-estate fund firm Brookland Partners.

Wilson explains that both types of lending also consider the financial strength of the sponsor/borrower and their experience and track record in managing similar companies or hard real estate assets. As such, consideration of the broader macro environment is also important in considering the impact on performance of the underlying assets and the resultant decline (or increase) in value and cashflow.

“Real estate debt is typically secured on the underlying property and therefore benefits from preferred creditor status,” explains Wilson. “The security of position of corporate debt depends upon the type of debt issued and therefore may be more difficult to realise and/or underwrite.”

This has more to do with the valuation principles being different for both and therefore requiring specific skill sets in considering the refinancing opportunity and risk.

Over the last year and particularly the last six months, Brookland has seen the re-emergence of a number of lenders and the arrival of new lenders who are now targeting European real estate debt. These include clearing banks, investment banks, pension funds, insurance companies, debt funds and fixed income investors.

“The return of CMBS as a funding source is also improving liquidity and helping to address the refinancing wall. While the gap is still significant the improvement in liquidity and need to deploy capital will start to chip away at the refinancing wall,” explains Wilson.