| Competitive funding environment in 2006 will be good news for treasurers |
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| Last year proved to be an interesting, and in some cases rewarding, year for Irish corporates in terms of bank and debt funding. John Cronin takes a look back at some of the significant features of the debt markets during the last 12 months. |
The year ending December 2005 has been very interesting, and for many corporate treasurers very rewarding, as they have taken advantage of the availability of bank and other debt funding at levels not seen for a number of years, and greater competition between banks and other debt providers. Some of the most significant features of the year have included:-
Refinancing of bank debt
For a number of corporate treasurers, 2005 gave them an opportunity to refinance bank debt from a somewhat unusual position: they dictated the terms and the pricing of their loans.
As one corporate after another lined up to refinance or simply reprice existing deals, bankers were obliged to accept significant reduction in margin, refinement in financial ratio covenants and, in some cases, amendment to general operating covenants. Banks did, of course, receive front-end or arrangement fees and often bank syndicates were reduced in numbers so that key or core relationships between them and their borrowers were confirmed and consolidated. It is also interesting to observe very recent trends in the UK and European corporate banking market where Barclays, HSBC, Standard Chartered, Banco Santander and Bancaja have sold or transferred their risk on major corporate loan portfolios through CDO offerings. The principal reasons for these transactions are regulatory capital with Basle II pending and efficient management of corporate risk on their balance sheets.
US private placements
A number of major Irish corporates have, in the past, raised medium to long term funding by means of a US private placement transaction. The appetite from US investors/debt providers has now increased such that in 2005 a number of Irish corporates have accessed this market for the first time. The all-in pricing (including swap costs) achieved in these deals has been very competitive as compared with bank borrowing which explains (in part) their popularity. The most successful transactions have had a number of common features: an up-to-date syndicated bank facility, negotiated recently and which contained financial and other covenants which give the company reasonable headroom going forward, a balanced debt repayment profile and an unsecured asset base.
In the main, this type of transaction is best suited to a listed company, a company with investment grade or near investment grade status, a semi state entity or other corporates who have ambitions to become one of the same. In addition, this type of funding is best suited as part of a mix of funding which might comprise, say, bank debt, capital markets issues and, now, a private placement transaction, and each component will have a different maturity profile. A private placement is not appropriate for a number of corporates. In particular, they are not suitable for those who have secured loans or are subject to very restrictive covenants in relation to the operation of their business. This is because the ability to amend or obtain waivers in respect of covenants or amendments is quite limited and often quite costly to the borrower. The transactions may only be unwound or terminated early at a cost, sometimes a considerable cost, to the borrower. This is because most US placees will enter into individual swaps to underpin their own funding. Thus, to break the transaction early will leave the borrower open to paying the break costs associated with ‘making whole’ the lender by reference to the profit that it assumed it would make over the life of the deal. Accordingly, it is often recommended that a corporate would review with its advisors, and possibly refinance, its existing bank debt before approaching the US private placement market.
IFRS – implications for loan documents
Notwithstanding warnings issued in 2004 by, amongst others, the Association of Corporate Treasurers, it was really only in 2005 that corporate treasurers and bankers started to consider the impact that the changes to the International Financial Reporting Standards would have on financial and other relevant covenants in loan and debt transactions. It was recognised that the introduction of IFRS was likely to have a significant impact on reported earnings of companies and on key aspects of their balance sheets. There would be consequences for both lending decisions which would affect both borrowers and lenders. One major change to occur was in the measurement basis used in company accounts – with the result that a change in a reported financial performance may be due not to a change in the underlying performance itself but perhaps to a change in the manner in which that performance is measured. Changes in reported profit and the position under IFRS could alter the key ratios inherent in debt covenants resulting in higher incidents of technical breaches. The impact of the changes are likely to extent beyond the introductory phase and to have a continued effect on volatility of earnings and, thus, may increase in the future the probability of debt covenants being breached. One consideration for both borrowers and lenders is whether a ‘rolling' GAAP or a ‘frozen' GAAP should be used. Some major Irish corporates have this year decided to meet this challenge head-on and, consequently, have switched immediately to IFRS and spent some time with their lenders explaining to them the changes and the impacts of the change in accounting treatment. In most such cases, such approaches have been very well received.
Project financing
For large corporates looking to effect stand-alone limited recourse or full non-recourse project financings in respect of new ventures or transactions, 2005 has proved to be a significant year for them. Increasingly, lenders are prepared to consider project financing for corporates in one-off projects or specific transactions, particular in the energy, property and ‘quasi’ PPP areas. The competition to finance such transactions is quite fierce, with pricing reduced significantly compared to recent years. In addition, the covenant package and a level of sponsor guarantee/support is often less than that which would have been mandatory just a couple of years ago. From a company’s prospective, these transactions should be above a certain minimum size (say, ?30m and preferably much higher), because of the large amount of work involved, the intensive nature of the negotiations and the transaction costs involved. They enable a sponsor/borrower to participate in new market areas without jeopardising their balance sheet. If structured properly, they should enable the project, once it is up and running, to be capable in a few years of being refinanced on even finer pricing and, perhaps, being capable of being securitised. The latter point may often attract new potential lenders to this type of transaction and thus drive pricing down even further. A key element of success in any such transaction is the forward planning by the corporate treasurer and his/her advisors.
2006
For corporates, the availability of comparatively low cost funding and competition between funding sources is expected to continue in 2006. |
John Cronin is a partner in McCann FitzGerald
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