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PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)
Amsterdam Institute of Finance Joseph V. Rizzi December, 2015
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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 2
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Debt Options Term Amortization Covenant Call Seniority Secured Revolver 5 – 7 Bullet FULL YES Term Loan A 40% in first 5 years Institutional Term Loans 7 - 8 1% per annum / bullet Covenant Lite 8 - 10 1% per annum / Bullet LIGHT Mezzanine 10 + PREMIUM NO Depends High Yield NO&YES Holding Company PIK Bridge Term Loans 1 - 3 Second Lien 8-9 Unitranche Yes Unsecured 1-10 1% P.A./Bullet No OPCO/PROPCO 10+ 1L The above table shows the features of different debt options available to issuers The availability of the different options is subject to market conditions 3 Amsterdam Institute of Finance December, 2015
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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
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Sponsor Based Debt Financing Allocations and Capital Providers
Providers of Capital Banks, Commercial Banks, Securities Firms Institutional Investors Private Equity Funds and Co-Investors Hedge, Mutual, Pension Funds CLOs Insurance Companies Others (e.g., Financing Companies) (BDO) Private Debt Funds 1L 2L Equity Other Debt Capital Structure Facilities Revolving Credit Facility Term A Loan (Tla) Special Purpose Facilities (e.g., Acquisition Line Term B Loan (TLb) Second Lien High Yield Bonds (incl) PIK Mezzanine Unitranche Warrants Preferred Equity Common Equity Leveraged Loans – Pro Rata Tranche Asset Backed Loans Leveraged Loans- Institutional Tranche Leveraged Loans – Pro Rata Tranche Senior (Including Cov – Lite) Junior Debt Equity Based on amended HBS case exhibit Amsterdam Institute of Finance December, 2015
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Complex Corporate Structure
Equity #1 Equity #2 Equity European Holding Company #1 European Holding Company #2 Preferred Stock NEWCO High Yield/Sub Notes Collapsed After Closing Bank Deal with Upstream Guarantee 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 Domestic Operating Subsidiary Domestic Operating Subsidiary Foreign Operating Subsidiary* * Tax limitations surrounding guarantees from foreign subs. Amsterdam Institute of Finance December, 2015
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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 - Public Disclosure - Cash flow control - Call Premium - Bridging - 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 7 7 Amsterdam Institute of Finance December, 2015
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LBO Transaction Structures
Senior Senior Senior Senior Senior Only +2L +Mez +2L+Mez +HYB Jan-Sep % 15% % % 20% 5% - 20% % 10% 5% - 30% % 5% 10% - 20% % 5% 10% - 20% % - 20% - 20% % - 25% - - % 5% 65% 10% - % 15% 15% 30% - % 10% 40% 25% - Source: S&P Capital IQ Amsterdam Institute of Finance December, 2015
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Non Investment Grade Loan Market
Bank Oriented Revolver T/LA Institutional Investor T/LB 2L Regulatory Leverage “Test”: <6X EBITDA Decreased Volume Less issuance as strategic acquirers crowd-out PE Amsterdam Institute of Finance December, 2015
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New Western European Leveraged Loan Syndications Monthly Volume
Amsterdam Institute of Finance December, 2015
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Average Price of the Credit Suisse Western European Leveraged Loan Index
Amsterdam Institute of Finance December, 2015
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Western European Leveraged Loan Market Size: Institutional, TLAs and Bank-held Facilities
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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 9 Mos 2015 Volume: U.S $10B EUR $.6 B Issues: - Inter-creditor - Standstill Agreement - Obligations - New Investors Behavior in a Workout bought at discount CLO Rating Impact % limit on 2L paper Amsterdam Institute of Finance December, 2015 13 13
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Unitranche Hybrid Senior/Mezzanine/2L 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 Increased Popularity Following Crisis When 2L and CLO Stalled Blended Rate: Target Returns Around 7% PIK Portion Amsterdam Institute of Finance December, 2015
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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 15
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‘OpCo \ PropCo’ Financing (1)
By structuring the financing of a pool of assets with a credit quality stronger than the corporate credit as a whole, ‘OpCo’ \ ‘PropCo’ financing can provide a cost effective source of (acquisition) financing. Example:- Target company de-merged into ‘PropCo’, which owns the real estate assets, and ‘OpCo’, the operating company. Banks finance ‘PropCo’ acquisition of properties at agreed Loan to Value ratio. ‘PropCo’ leases the real estate assets to ‘OpCo’. ‘PropCo’ debt refinanced by traditional Property Lenders or via Commercial Mortgage Backed Securities (CMBS) market. ‘OpCo’ required to service the acquisition debt not assumed by ‘PropCo’. REIT 16 16 Amsterdam Institute of Finance December, 2015
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‘OpCo \ PropCo’ Financing (2)
BidCo Financing Notes Approx. 100% Approx. 100% OpCo PropCo Rental Payments 17 Amsterdam Institute of Finance December, 2015
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High Yield Bonds Longer Term Bonds Public or Private
7-10 years and longer 4/5 NC Public or Private 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) U.S. ($) Europe (€) 9 mo Market Size T B Amsterdam Institute of Finance December, 2015 18 18
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Key High Yield Terms Issuer Status Degree of subordination
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 19
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European Mezzanine Terms (Currently dead due to HYB, 2L 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 20 20 Amsterdam Institute of Finance December, 2015
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PIK Spread 825/900 Toggle 900-1000 Term 7.5-10 Call 5xNC Leverage
Pay if you can toggle Ratings – NR or CCC Eats up equity Holding Company Issuer Characteristics Spread 825/900 Toggle Term 7.5-10 Call 5xNC Leverage 6.5x+ Amsterdam Institute of Finance December, 2015 21 21
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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 22
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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
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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
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Changing Nature of Leveraged Finance Capital Structures
Joe Rizzi Presentation for AIF - October 2006 Changing Nature of Leveraged Finance Capital Structures Increasing layers of debt Directed at different investors Intercreditors conflicts Present Common equity Hybrid preferred (0.5x) PIK notes (0.5x) Unsecured/mezzanine (1x) Carve-out collateral (1x) - OPCO/PROPCO Second lien loans (1x) Senior secured bank loan (4x) - Amortizing T/LA – 20% - B tranches – 80% H Common equity Unsecured/mezzanine (1x) Senior secured bank loan (4x) - Amortizing T/LA – 40% - B tranches – 60% FDX – 5x + PPX – 7.5 + FDX – 6x + PPX – 9 + Amsterdam Institute of Finance December, 2015 25 25
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