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Shifting Tides: Decoding the Credit Markets, Structuring Debt in Volatile Times June, 2012 Sycamore Associates LLC.

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Presentation on theme: "Shifting Tides: Decoding the Credit Markets, Structuring Debt in Volatile Times June, 2012 Sycamore Associates LLC."— Presentation transcript:

1 Shifting Tides: Decoding the Credit Markets, Structuring Debt in Volatile Times June, 2012 Sycamore Associates LLC

2 September, 2008: Try to Remember (“Hell is empty, and all the devils are here”…Shakespeare, The Tempest) Sunday September 14, 2008: Lehman files for bankruptcy protection AND Merrill Lynch is sold to Bank of America Monday September 15: Dow down 504, worst day in 7 years September 16: AIG Liquidity Crisis, Fed takes 79% stake September 19, Fed offers temporary increase to FDIC insurance to prevent run on banks Previously: Bear Stearns failure, Citi capital raising Bank failures highest in 13 years Regulators onsite at I-Banks GM, Chrysler File for bankruptcy 2

3 Sycamore Associates LLC Bank Capitalization Issues and the Ripple Effect: Then Capital Strains=Tight Credit Higher Cost of Capital, for all Financials New Ownership Strategic Changes Credit Scrutiny Down grades “ as abundance of caution” Changes in return disciplines New regulatory environment TARP implications

4 Sycamore Associates LLC Current Events September 2009 Default rates: August 20,2009: Moody’s announces it believes default rates will NOT go as high as previously predicted (15%). Moody’s cites the re- opening of the high yield bond market as a positive factor Bond Market trends: Capacity is still good Does success in IGR really translate to other markets? High Yield Market re-opens with $71B issuance YTD, a causative factor for the Moody’s prediction regarding defaults Private Placements: will investors go for a broader swath of credit profiles? Still to be seen We begin to see 3 year revolvers, Amend and Extend Some banks have repaid TARP funds Regulatory issues remain hanging over the heads of banks, especially those with TARP funds Credit underwriting is still paramount, but –We have heard our first comments from banks looking ahead to create earnings for 2010, if not 2009

5 Sycamore Associates LLC Then the World Turned..2010 was a Very Good Year Syndication loan market volumes rebound Non-sponsored lending peaks in 4Q; recovers from 2009 lows Refinancings drive bulk of loan issuance; new money picks up in 4Q Competition intensifies; terms continue to loosen Sponsored issuance logs second highest quarter, continues to gain market share Dividend recaps hit a new quarterly record LBO lending increases Institutional issuance recovers from 2009 lows; still half of 2007’s peak levels Yields tighten to pre-crisis levels Middle market premium narrows in December confidential 5

6 Sycamore Associates LLC Flash Forward, Spring and Summer 2011 Spring…. AT&T $20B bridge loan – underwriting followed by immediate syndication success Summer…. Express Scripts $14B bridge loan – underwriting followed by successefull syndication but….European banks appetite limited confidential 6

7 Sycamore Associates LLC Flash Forward, Spring and Summer 2011 What next? Euro debt concerns continue Euro banks talk about liquidity Banks are eager to lend, but…a more cautious note has emerged M&A catching fire? confidential 7

8 Sycamore Associates LLC Ripped From the Headlines…… 8

9 Sycamore Associates LLC Back to the Future confidential9

10 Sycamore Associates LLC Covenant levels in the investment grade market have loosened so far this year when compared to 2009, evidence that the market is easing back towards issuer friendly terms. Another sign highlighting this shift is that there are fewer covenants appearing in deals. For packages which included at least one financial covenant in 1Q-3Q10, 43% of deals for BBB rated borrowers contained only one covenant compared to 39% in 2009. Similarly, 49% of 1Q-3Q10 packages contained two covenants compared to 38% in 2009. On the higher end of the spectrum, covenant deals with 3 covenants decreased from 17% in 2009 to only 5% for 1Q-3Q10. Covenant levels in the leveraged loan market have been loosening in 2010 compared to last year, a sign that lenders are willing to ease up on structure in order to stay competitive. For leveraged deals with an institutional tranche, the average maximum debt to EBITDA ratio was 4.97 times in 1-3Q10, much higher than 2009's average of 4.48 times, and even higher than 2008's 4.84 times. For pro rata credits, the average debt to EBITDA level has jumped to 4.5 times for 1-3Q10 compared to 3.81 times in 2009. BBB rated borrowers see increase in market share of loans with one to two covenants Debt to EBITDA cap loosens for leveraged issuers Covenants and Structure: Investment Grade and Leveraged Trends – 1997 to 2010 (source: ThomsonReuters LPC)

11 Sycamore Associates LLC confidential11 State of the Refinancing Wall Amend and extend has helped push maturities out

12 Sycamore Associates LLC High Volatility Becomes a Trend Many well-managed companies are well- positioned with cash and low debt levels A more cautious tone prevails with a renewed focus on structure and ‘story specifcs’ –LIBOR Floors: going, going…….back? –Half of deals in Q4 2010 had LIBOR floors –Only 11% had one in Q1 2011, BUT: –Update confidential 12

13 Sycamore Associates LLC The Risk On, Risk Off Teeter Totter Drivers confidential13

14 Sycamore Associates LLC Biding Time – Safety at the Short End confidential14

15 Sycamore Associates LLC Uncertainty Abounds: this train could stop Geopolitical Economic Housing Market UK economy struggles Germany robust Dollar woes Debt, Debt, Debt Return pressures confidential 15

16 Sycamore Associates LLC Regulation Matters Regulation is the new driver at banks and other financial institutions. –Dodd Frank (US) – “proprietary trading” –Basel (global) – leverage ratio and liquidity requirements will results in significantly higher capital over the next few years –Jamie Dimon, CEO, JPMorgan: “Lending costs will increase, depending on the type of customer and the type of loan. It is possible that some companies may no longer go to banks for loans.” (September 2010) –2012: Peer to Peer lending emerges confidential 16

17 Sycamore Associates LLC Regulation Abounds Basel III –Liquidity coverage ratio –Net stable funding ratio Dodd Frank and the Volcker Rule Leveraged Loan Guidance (in the US) Various other rules: FATCA

18 Sycamore Associates LLC Regulation Matters to All of Us Higher capital and liquidity requirements will most likely mean more focused client relationship lending (and/or higher borrowing costs) as rules are implemented The playing field may not be level –Timing of implementation may vary globally –Some differences in local rules Systemically important financial institutions (SIFIs) face higher requirements

19 Sycamore Associates LLC Impact of Regulation And what of the “shadow market”… We are living through a “case study” in credit, markets and regulation Peer-to-Peer lending: John Mack leads the way?

20 Sycamore Associates LLC 20 – Overall – Slowing global growth and deepening Eurozone sovereign debt crisis – European banks facing funding constraints, changing strategies – Rising costs of funds across geographies – Leveraged finance – Shorter, steeper cycles? Technicals swing between polar opposites: from overheating to over-correcting – Aging CLOs are not being replaced proportionally – Challenges in underwriting with an evolving investor base – Investment grade market – Variability in bank behavior – higher probability of surprises – Will market continue to digest bank pullback? How much pressure will this put on capacity? – Basel III and changes to internal models which dictate pricing must go up coupled with shorter tenors; Unfunded RCs will become prohibitively expensive Source: Thomson Reuters LPC Quarterly Survey Aggregated survey responses across themes Conclusion: What are the biggest issues/changes facing the loan market?

21 Sycamore Associates LLC Appropriate Markets? Who Invests? Senior debt: Unsecured Public Debt High-yield and Secured Debt Asset based Mezzanine Equity or equity- linked Banks, Insurance Companies Funds, Insurance Hedge funds, Insurance Co., some banks Banks and finance Co. Funds and PE Public and PE confidential 21

22 Sycamore Associates LLC Europe vs. US vs. ASEAN Markets Linked but not Lockstep confidential 22

23 Sycamore Associates LLC Update on negotiating changes Boilerplate changes LIBOR floors, etc fees confidential 23

24 Sycamore Associates LLC Market Today Trends and outlook –Global market –Investment grade –Leveraged Overview of Pricing Regulatory developments Future themes for the loan market

25 Sycamore Associates LLC Source: Thomson Reuters LPC Global syndicated lending dropped 30% to $646 billion in 1Q12 Issuance ($Bils.) Global syndicated loan volume 4

26 Sycamore Associates LLC Source: Thomson Reuters LPC Change in issuance year over year Year-over-year, lending in EMEA shows biggest drop 5

27 Sycamore Associates LLC 27 In the US…1Q12 leveraged lending was up 42%; investment grade was down 54% vs. 4Q11 Issuance ($Bils.) Source: Thomson Reuters LPC U.S. Loan Issuance

28 Sycamore Associates LLC 28 Source: Thomson Reuters LPC; TR LPC’s Quarterly Survey U.S. IG New money vs. refis Quarterly survey results 22% of lenders struggle with capital constraints Capital constraints? 22% of investment grade lenders are more constrained this year with regard to total availability of capital 11% are less constrained 67% have the same amount of capital Outlook for the refinancings pipeline this year? 11% say anemic 67% say slow but steady 22% say robust Will the make-up of bank groups change in 2Q? 42% say yes 29% say maybe 29% say no

29 Sycamore Associates LLC 29 Higher quality issuers continue to utilize MBP Source: Thomson Reuters LPC Volume of IG loans structured with Market Based Pricing

30 Sycamore Associates LLC 30 Longer tenors continue to dominate structures 364 day 3 year 5 year Source: Thomson Reuters LPC Tenor distribution by rating 4 year

31 Sycamore Associates LLC 31 1Q12 High yield bond issuance reached $91 billion, breaking 4Q10’s $83 billion record Source: Thomson Reuters, Thomson Reuters LPC Annual & quarterly institutional loan and HY bond volume

32 Sycamore Associates LLC 32 $32 billion in HY bonds were used to pay down loans in 1Q12; select issuers pursued A&Es Source: Thomson Reuters LPC A&E Volume 30% of HY bond proceeds were used to pay down loans in 1Q12

33 Sycamore Associates LLC 33 Refi activity drove leveraged lending in 1Q12 Source: Thomson Reuters LPC Leveraged lending Institutional loan issuance only

34 Sycamore Associates LLC US Market Indicative Investment Grade Pricing *spread over Libor

35 Sycamore Associates LLC US Market Indicative Leveraged Loan Pricing

36 Sycamore Associates LLC US Market Indicative Mid-Corporate Loan Pricing

37 Sycamore Associates LLC Structure Guidelines and Pitfalls Know your own credit profile Research similar deals Survey your bank group Ask what risk rating your company has internally Ask banks to share their return dynamics with you confidential 37

38 Sycamore Associates LLC Middle Market Fares Not As Well Ugly Stepsister? Less flexibility in covenants Less pricing reduction Still credit-profile driven Update confidential 38

39 Sycamore Associates LLC Covenants: The High-Grade vs. Mid Market Divide More covenants in MM Lower leverage thresholds Higher coverage levels Based on generally more conservative underwriting standards Reflects recent experience of downturn, lower capitalization, reduced access to capital markets confidential 39

40 Sycamore Associates LLC Pricing Dependent on many factors, including sponsorship, asset support, but Generally can negotiate less: E.g. reduced guaranties, foreign subsidiary requirements Baskets for acquisition and investments confidential 40

41 Sycamore Associates LLC But What’s to Come? confidential 41 True is it that we have seen better days." - William Shakespeare, As You Like It, 2.7

42 Sycamore Associates LLC What Does the Future Hold? There are some clouds on the horizon… –Impact of sovereign risk Funding costs are higher for many institutions –Basel III capital regulations have stringent capital AND liquidity requirements for financial institutions Phase in delayed for several years –CRE still a huge issue among smaller regional financial institutions –Investor appetites confidential 42

43 Sycamore Associates LLC Q and A Sycamore Associates Risk, Capital Structure and Treasury Solutions Winifred Pinet, Marcia Banks, Gina Strumolo, Newsletter, confidential 43

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