The precipitous decline of the credit markets has forced banks to change the way they market and sell debt. The difference between loan and bond investors has shrunk to almost nothing. And heavily indebted banks, beholden to those same investors, have adjusted accordingly. A couple of recent deals in the US illustrate how the convergence of the two markets has deepened. Michelle Sierra Laffitte and Joy Ferguson report.
The sale of both classes of debt is a relatively new tack. Goldman Sachs’s sales and marketing strategy for the LBO debt is like
Normally, underwriters launch the bank deal first, wait a week or more and begin a roadshow for the bonds. Even as the two markets were beginning to be more correlated, the sales strategies for the two pieces of the capital structure were different.
Now that many of the loan-exclusive investors have disappeared with their own debt dilemmas, more bond investors, hedge funds and equity mutual funds – fluent in both bonds and loans – are taking up the slack. That requires that they be given a better opportunity to discern the relative value of all the debt being sold by the company.
So arrangers have compressed the timing of the launch of bonds and loans, issuing the price talk for both at roughly the same time. “The theme is convergence of the markets; convergence of timetables,” a banker said. “The bank loan process and timing now resembles a bond process and timing.”
Bank debt and bond investors used to invest more or less ignorant of each other’s prices. In many cases savvy bankers would play the two markets off against each other. In the past year typically oversubscribed loan commitments came in before bond commitments on the same financing. That gave arrangers the upper hand with bond investors. In several buyout financings, loans were increased in size at the expense of bonds.
“When the market was good, you’d put out the bank deal early, get as much as you could, then maybe play the bonds as well,” the banker said. “Nobody really cared about pricing or timing because you wanted to buy as much as you could.”
Arrangers have adjusted to the changes as their bread-and-butter investor clients, CLOs, have virtually disappeared.
“What is going to happen now is that you are going to get timing compression, since CLO buyers purchased 50% of the loans for sale, and they are no longer in business for all practical purposes,” another banker said. “The new buyers are hedge funds and other investors that had previously been interested in the high-yield bond deal.”
These crossover investors have put more emphasis on the timing and the pricing of both asset classes. They want to evaluate them at the same time on a relative value basis. The traditional, more disjointed, marketing model made life more difficult for crossover investors.
“[As an investor] when the markets turned south, not only did you care about the timing or pricing, you were actually going to refuse to be firm on your bank deal order until you knew how many bonds were going to get sold and what the pricing was,” the first high-yield banker said.
That method is slowly losing ground as the core group of investors changes and the market becomes more volatile.
“We used to set the price of the bank deal when we launched it and it wouldn’t move; a month later it will still be the same pricing,” the banker said. “Now we are waiting until the last minute to set the pricing for a new deal, just like a bond. This shows you how much more hedge funds are forcing the marketing process to be more like a bond roadshow than a bank roadshow and they are forcing pricing to change.”
“Those deals getting done in July and August really forced the issue of relative value and timing because people were uncomfortable buying the loans when they didn’t know when the bond was pricing or vice versa,” the first high-yield banker said. “That was the series of deals that brought the issue to the front burner.”
At the time, credit committees were getting uncomfortable with the funded debt they held. “You also had the phenomenon of market volatility where these deals were suddenly being funded, so couldn’t just wait,” he said. “Some things were getting pushed together because you were waiting to launch them and then all of a sudden they were getting funded at the same time.”
This is not to say that all bank deals will structure their marketing in the same way in the future. Other deals, like Basell, are expected to stagger the launch of the bank and bond components at different times.
This week, however, crossover investors will get what they want and if underwriters want to continue to chip away at their debt burdens they will have to listen to the investors for months to come.
Alltel is marketing roughly US$6bn of its US$14bn term loan B and at least US$3bn of its US$7.7bn of cash-pay and PIK notes. The loan will be split into three TLB tranches with different call structures. Just like its two predecessors earlier this autumn, the B2 piece is expected to kick off the process.
The company will also be adding a maintenance covenant to what was a covenant-lite deal. Citi, Barclays and RBS are also lenders.
Proceeds from the deal will finance the purchase of Alltel by TPG Partners and Goldman Sachs Capital Partners. The merger is expected to close on November 16.