A torrent of refinancing activity has hit the private equity marketplace in the new year, including many deals that are covenant-lite.
Among the portfolio companies refinancing their debt are the children’s retailer
Some of the refinanced loans were negotiated as recently as November, in an indication of how quickly credit conditions have improved for borrowers (see table at right).
And in some cases, the revised terms are sufficiently better for the borrower that ratings agencies are upgrading their credit ratings.
“Rates are low now. They are going to go up,” said Ronald Kahn, a managing director at the Chicago investment bank Lincoln International LLC and the head of its credit advisory service. “Why not refinance now? If you’re a CFO, you’d be crazy not to.”
Certainly low rates are a factor for investors in credit; Bill Gross, the co-CIO of the big bond investor PIMCO, complained in a commentary this month about low Treasury yields, urging investors instead to look at the higher returns of asset classes including bank loans and corporate high-yield bonds, which he called “safe spreads.”
Another factor is the surge of activity at the end of 2010, as dealmakers tried to close transactions before an expected 2011 increase in capital gains taxes (averted at the last minute when President Obama and Congress agreed to extend the lower rates). As a result, the new year began with more than the usual seasonal lull in deal activity, reducing the supply of borrowers in the market seeking financing.
To get one measure of lenders’ hunger to do deals, consider the renewed popularity of covenant-lite loans. According to Thomson Reuters LPC, which covers the loan market, covenant-lite loan volume this year has already reached $4.7 billion. In all of 2010, the volume of such loans totaled only $5.6 billion.
Company managers and the sponsors that back them tend to favor covenant-lite arrangements, because they give the portfolio companies more flexibility in how they use their cash. On the other hand, lenders tend to dislike such deals because they raise the risks of nonpayment.
Lenders do not expect the surge to fade anytime soon, Thomson Reuters LPC said. “If loan demand continues to outweigh supply and covenant-lite issuance continues at this same pace seen, volume for the year could be trending back to the levels we last saw in 2007 of $57 billion.”
For instance, Gymboree, taken private last fall by Bain Capital, kicked off February by announcing that it planned to refinance an $820 million term loan, eliminating maintenance covenants and capital expenditure covenants and extending the maturity by three months. The price for this deal: 12.5 basis points on the loan, raising the rate to LIBOR plus 412.5 bps. On the other hand, that was offset somewhat by pricing the loan at par rather than at a slight discount.
Another portfolio company, Dunkin Brands—which is sponsored by a consortium including Bain Capital, The Carlyle Group and THL Partners—is pricing a six-year, $1.25 billion term loan at LIBOR plus 300-325 with a 1.25 percent Libor floor, where as recently as last November, a seven-year term loan priced at LIBOR plus 425 with a 1.5 percent Libor floor.
And Realogy, which is backed by Apollo Management, was able to land a $2.5 billion senior secured term loan due 2016, extended from 2013 for the price of 125 bp increase in spread to LIBOR plus 425. The new loan completed a complex reworking of the troubled Realogy’s capital structure; in January, the company had pushed out the maturities on some of its debt and expanded the use of junior convertible notes.
As a result, Standard & Poor’s Ratings Services raised its corporate credit rating on Realogy one notch to ‘CCC,’ admittedly still a highly speculative grade, but an upgrade nonetheless. As Emile Courtney, S&P’s credit analyst, explained: “The upgrade reflects Realogy’s improved liquidity profile following the closing of the transactions, which decreased the level of senior secured first-lien debt in the company’s capital structure.”