VideoDarren Wells knows a good deal when he sees one. The senior vice president for business development and treasurer of $19.7 billion Goodyear Tire & Rubber Co. seized on favorable credit-market conditions in 2003 to restructure approximately $3.3 billion of credit facilities. Wells swung into action again in 2004 when he refinanced much of that debt on even better terms, then again in 2005 when still better terms could be had. Ultimately, the tire maker wound up with five- and six-year facilities on terms a Single-B-Plus credit could only have dreamed of a few years earlier.
Given some signs that the good times were coming to an end, Wells was understandably a little surprised when bankers began showing up at his door again in early 2006, encouraging him to refinance for the fourth time in four years. "I saw what might have been the most aggressive credit market we had seen," he recalls. The company was receiving regular offers to refinance all that debt yet again at lower interest rates and with fewer financial covenants. Interest-rate spreads over Libor were compressed to levels Goodyear had never seen before. "These things," says Wells, "were indications of the loosest credit requirements you could hope for."
But good times do come to an end. While bank credit remains readily available today, Wells noticed that by the middle of this year, many of those bankers had stopped showing up. With more evidence of an economic slowdown and more concern about inflation, Goodyear was no longer the recipient of generous offers. "People weren't coming to me and saying, 'Here it is, but it's much worse,'" he says. "They just stopped coming, which means they probably couldn't provide enough benefit to make it sound worthwhile."
A Turning Point?
Wells has seen other signs that the tone of the credit market may be changing. Part of his job involves estimating the prices various Goodyear businesses might command on the auction block. As part of that, he analyzes how much leverage potential buyers might be granted. "What we have heard," says Wells, "is that there may be a marginal reduction in the amount of leverage that financial buyers can get to purchase businesses." He estimates that the amount of financing banks are willing to provide in terms of multiples of EBITDA has fallen from earlier levels by roughly 0.25 times. That's not a dramatic change, but it may indicate that the credit cycle has reached a turning point.
There are other hints, as well. Fitch Ratings currently has about 15 percent of the industrial companies it rates on negative outlook, up from 11 percent a year ago. And Meredith Coffey, director of analysis for Reuters Loan Pricing Corp., notes that the supply of high-yield loans being brought to market by corporate borrowers has jumped dramatically in the past year, threatening the tenuous balance between loan supply and investor demand. Most of those loans are sold to institutional investors, such as hedge funds. Last year at this time there was about $19 billion of such loans in the pipeline, Coffey says. This year, there is about $57 billion. Because of the shift in the supply-demand equation, she says, her firm has observed spreads increasing on these leveraged institutional loans, which tend to presage spreads on bank-only leveraged loans. In addition, she says, "we've also seen pushback on doing deals without covenants, so deals will be more heavily covenanted going forward. And there's no more squishiness around what defines EBITDA, where projections are going, things like that."
Gauging a Downturn
Some observers have been predicting an end to easy credit for some time, and have likened recent conditions to a bubble not unlike the one in the equity markets during the 1990s. With the Fed driving rates higher, these observers fear that it's just a matter of time before weaker and more highly leveraged companies begin to default on their debt, prompting banks to set aside larger loan-loss reserves. That, in turn, would squeeze bank profits and lead to higher-cost loans with stricter loan covenants. Slowing economic growth — U.S. real GDP rose at a 2.9 percent annual rate in the first half of 2006, down from a 5.6 percent rate in the first quarter — would exacerbate the problem.
Thus far, that scenario has failed to play out. Through the first half of 2006, default rates on high-yield bonds remained at below-average levels, according to Fitch Ratings. Meanwhile, banks continued to reduce, not raise, the number of covenants they were imposing on loans, both to investment-grade and non-investment-grade companies. According to data compiled by Fitch, only 60.9 percent of loans to non-investment-grade companies included any sort of debt-coverage covenant in the first half of 2006, down from a recent peak of 83 percent in 2003. And only 65.4 percent included any sort of leverage covenant, down from a recent peak of 78.2 percent in 2004.
Covenants are even less prevalent in the investment-grade market. Laurie Stewart, vice president and treasurer of $8.1 billion Air Products and Chemicals, notes that her Single-A-rated firm refinanced its revolver in May, bumping its size up to $1.2 billion from $700 million and eliminating one financial covenant while softening the language of some others. The revolver has a five-year term. "We've been talking to our banks recently, getting some updates, and the market seems just as good as ever from a corporate-borrower's standpoint," agrees Terry Rasmussen, assistant treasurer of $11.2 billion Arrow Electronics.
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