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Back on Track

It's been a frightening year for credit-starved companies. Can they relax a little?
Vincent Ryan, CFO Magazine
October 1, 2009

In September 2008, as the fishermen who star in the hit show The Deadliest Catch crisscrossed the Bering Strait in search of snow crab, the show's creator, Discovery Communications, braced for a major squall. The programmer had gone public the same week that Lehman Brothers filed for bankruptcy and Bank of America gobbled up Merrill Lynch. On the cusp of the biggest storm in banking in 70 years, the company needed to adopt a more durable capital structure, one that matched its assets and its new stature as a public concern.

But the timing couldn't have been worse.

Discovery Communications CFO Brad Singer counseled patience, and after spreads tightened 400 basis points from January to July 2009, the $3.5 billion cable-television company pulled the trigger. It refinanced $1 billion of term loans and private-placement debt with an institutional loan and a bond offering, pushing out maturities from less than 18 months to 5 and even 10 years. The new debt didn't wipe out all of the old, though. "I'm an incrementalist," explains Singer. "Markets come and go, and as long as you have time, you're going to get the best terms if you can pick when to access the market."

For many companies, that "when" may in fact be right now, because financing markets have reopened — if even just a crack. "This is an excellent time to lengthen your maturities if you can," says Varun Bedi, managing director of Tenex Capital Management, a restructuring and investment firm. "It's not a huge opening, but it's much better than I would have thought. Markets won't open a whole lot more, and they may well shut again once people realize the economy will take a long time to recover."

Not every CFO who needs to is actively refinancing debt, however. In a July CFO survey, 31% of finance executives said their approach to financing the next three years is to "hope for a recovery in bank lending that eases our access to bank credit." But to stand and wait could be a big mistake. The queue of companies refinancing is growing long, thanks to the leveraged-buyout boom of 2005 to 2007. About $455 billion — around 91% of the institutional loan market — matures between now and 2014, says Standard & Poor's.

If it's time to lessen refinancing risk, you have some options, but they may not include a relationship-bank lender or an unsecured revolving line of credit. Indeed, companies are paring their bank debt as they prepare for a scenario in which that source won't come back for years.

Time to Bond?
What will be the most attainable and cost-effective form of capital over the next three years? Finance executives surveyed by CFO think it's bonds. There was $103 billion worth of high-yield issuance in the first half of 2009, $32 billion of which paid off leveraged loans, according to Thomson Reuters. "Almost all of the issuance [currently] is refinancing of bank debt," notes Diane Vazza, a managing director and head of Global Fixed Income Research at S&P.

For companies dealing with tight bank covenants and amortization, bond debt offers some relief. Bond covenants tend to be incurrence-based (measured at an event, such as an acquisition) rather than maintenance-based (continuously measured), and contain fewer restrictions on issuing more debt and selling assets. In addition, generally, companies find bondholders to be much "lower maintenance" than relationship banks or institutional debt.

"Institutional debt worked out fine for Blackboard Inc. three years ago," says Mike Stanton, the education-software company's senior vice president of finance and treasury. But he wouldn't be inclined to go that route now. "The term loan was a drain on finance and legal resources," he explains, "and it required time for senior executives to provide multiple presentations to potential bank participants as well as to work with external rating agencies." In contrast, says Stanton, the $165 million convertible bond offering Blackboard filed in June "was very time-efficient."

Adds Singer of Discovery Communications: "Ultimately, we want to move into the longer-term bond market. It's much deeper, so you get better pricing."

The high-yield variety is still expensive. In late August, the S&P speculative-grade composite was at 823 basis points, well off highs of 1,700-plus in late 2008 but 440 basis points above the long-term average. Defaults of junk debt and continuing credit downgrades may keep rates elevated, according to S&P Global Fixed Income Research.

Bond financing is also less flexible than a bank loan in some respects. "Bond debt usually has a couple of years of no-call and a higher redemption premium," points out Eric Goodison, an attorney at Paul, Weiss, Rifkind, Wharton & Garrison. "You're locked in for a longer period." Bonds are also tougher to amend, whereas bank lenders expect to be asked to ease terms.

Finally, more bond offerings now are secured by assets. When Brunswick sold $350 million of 11.25% notes in August, the bonds were secured by first-priority liens on the company's headquarters and its retail bowling centers, as well as second-priority liens on almost all of the assets that back Brunswick's senior revolver. "It used to be rare that you did a secured bond deal," says Goodison. "But what are your choices? Do nothing, or take advantage of what the high-yield market offers."


Bank Loans: A Reprieve?
The loan market may be a hassle for treasurers like Blackboard's Stanton, but it is also showing some signs of life. Volume is still at historic lows, but Thomson Reuters reported in June that "there is now a reprieve from market contraction."

Peter Crage, finance chief at Cedar Fair Entertainment, can attest to that. A leading regional player in amusement and water parks, Cedar Fair doubled in size through an acquisition three years ago. It took on a large cash loan to buy the Paramount Parks chain from CBS. When the bank-loan market seized up, having debt at five times EBITDA (earnings before interest, taxes, depreciation, and amortization) with a single bullet maturity in 2012 was uncomfortable, Crage says. So over the summer he began "stacking the debt out in tranches."

After six weeks of talks with 100 investors, Cedar Fair got $900 million of the company's $1.7 billion term loan amended and extended, says Crage. The price wasn't cheap: a 100% increase in spread and a near 10% reduction in Cedar Fair's revolving-credit facility. But Cedar Fair also positioned itself to delever on both an absolute basis and a bank-debt basis. The company can now incur new senior debt in the form of loans and bonds, as well as do leasebacks and asset sales.

The bond market is potentially one of Crage's future targets. "Our ability to access another credit market would be a big plus — it's quiet, long-term money," he says. At the same time, Crage realizes that tapping the high-yield markets will raise interest expenses and consume more free cash flow. On a blended basis, before the amendments, Cedar Fair's financing cost was approximately 6.5%. "With the very inexpensive debt we had before, we're blessed and cursed," says Crage.

The caveat in the loan market is that amend-and-extend deals will provide relief, but "only to a select group of names," says Thomson Reuters. The institutional loan market is far from returning to its freewheeling days, when collateralized loan obligations brought more than $300 billion of yearly appetite into the market. Some have defaulted or have been downgraded. Fewer CLOs scooping up loans in the secondary market constricts banks from selling their loans post-origination.

"If the economy perks up [we may reach] a normal level of financing, but it won't hit the bubbly levels it did," says Steven Bavaria, managing director of leveraged finance at rating agency DBRS.

What could temper the ability of small and midsize companies to refinance is the fact that nonbank investors in debt are disappearing or shrinking. Take the case of Gladstone Capital Corp., which finances purchases of business loans with a warehouse revolving credit facility. When the securitization market was still healthy, Gladstone's plan was to accumulate a large number of loans using the facility and then sell them to a special-purpose entity (SPE), which was, at the time, a way of providing inexpensive long-term debt to the company, says CFO Gresford Gray, Not only did the securitization market crumple, but last May Deutsche Bank declined to renew Gladstone's line of credit.

Long-term relationships with other lenders in the facility — BB&T and Key Bank — allowed Gladstone to refinance. But the new facility shrinks with time. "With the securitization market gone, we're looking at other forms of longer-term debt coupled with a smaller revolver," says Gray. Reducing the size of the portfolio, though, is also an option.

Securitization: The Survivors
While many securitization markets are not returning, companies can still tap one that has a chance of survival: accounts-receivable securitizations. Receivables securitizations allow companies to transfer their trade receivables to an SPE to obtain lower-cost financing. Securitization's name may be tainted, but the trade receivables kind is more favored than most.

"It's a survivor," says Adrian Katz, CEO of Finacity, which arranged a new facility for Cemex in July. "In a lot of ways the segment has been validated. You're not reading about defaults on these deals — they're performing."

Two advantages for investors: first, the maturity of trade receivables is closer to the duration of commercial paper, which SPEs often use to fund the credit line. Second, the methodology for calculating subordination changes over time, based on the actual performance of the assets. "When losses increase, reserves increase," says Katz. By contrast, "in a mortgage deal, whatever subordination you first set up, you're stuck with."

While advance rates (the percentage of receivables the borrower can draw down) are lower, receivables securitizations are still relatively cheap. Take Tech Data. The distributor of IT products was paying 4.56% on the outstanding portion of its $300 million receivables securitization program last October, but by April the rate had dropped to 1.72%. (The rate is based on commercial-paper rates plus a margin.) "The rates that conduits pay have come down with the overall interest-rate environment," says Charles Dannewitz, a treasurer at Tech Data. "Asset-backed securitizations are still a very cost-effective way to fund working-capital needs."

Other forms of asset-based financing usually pick up as banks tighten underwriting standards. Financing with commercial vehicles, plant, machinery, and office equipment grew robustly in 2008, although it has slowed a bit. According to the Commercial Finance Association's Asset-Based Lending Index, total committed credit lines rose 3.5% in the first quarter of 2009 before stagnating in the second quarter.


Not tying up equity with inventory is attractive. And for a lender to a distressed company, "it gives you more than one way out," says W. Craig Stillwagon, an executive vice president at PNC Business Credit. "The yields are attractive and the safeguards are there — it's not as risky as cash-flow lending, where you don't have a lien."

Finance companies are partly constrained by the banks. "There are more challenges today in capitalizing our company and getting sources to fund new opportunities," says John Curtis, executive vice president of asset-based lender First Capital. "As a nonbank lender, we leverage our balance sheet with capital from the banks."

Another problem for asset-based lenders (and their customers): across-the-board deflation in asset values. When the quality of receivables, the value of inventory, and the value of equipment fall, "it forces us to be more conservative on [loan] structures and adjust the borrowing base," Curtis says.

If a company has unencumbered accounts receivable and inventory, a reasonable amount of leverage, and adequate junior capital, asset-based lending can be a good option. It may cost more, but CFOs are willing to pay for greater flexibility, given the difficulty they're having forecasting in the current climate, says Greg Becker, president of Silicon Valley Bank. Asset-based lenders can provide money in this market because they can get closer to the collateral as a viable repayment source. "That gives the bank more control and mitigates risk," Becker says.

Taking the Medicine
Regardless of how fast or far business lending and credit markets snap back, CFOs have truly entered an era of self-help. "You need a business plan that addresses that 20% drop in revenue," says Bedi of Tenex Capital Management, "and you need to prove that there's a sustainable business long-term. You can't just ask the bartender for another drink."

Indeed, it can feel as if banks have cut patrons off altogether without so much as uttering "last call." But there may be a silver lining. Self-sufficiency — or at least striving toward it — can boost a company operationally. Take TJ Bednar & Co., a builder of energy-efficient homes in the Southwest, which is coping with the loss of large credit lines from four major banks last year. Needing a borrowing base to build anything, CFO Brock Qualls turned to "hard-money" lenders — private-money sources and investors charging 8% to 16%. It's not the horror story CFOs might expect. Qualls was able to put up vacant finished lots to secure the loans, and a surplus of contractors means TJ Bednar can build houses faster and draw less capital while a house is being built.

Qualls's goal is to make TJ Bednar debt-free in another year and eliminate all personal guarantees that the principals made to secure bank financing. At that point, Qualls plans to use banks only for major projects, and do as much financing as he can on his own. He is even investigating forming a dedicated investment pool. "We learned that having the cost-of-capital schedule as low as possible is not the way to go," he says. "We need to factor in other, higher-priced private investment that will help when banks don't want to do it any longer."

Extending maturities and adjusting debt structures give CFOs hope. Before Discovery Communications's refinancing, practically all of the company's free cash flow was devoted to amortizing debt. Now that money can be invested back into the core business — or, Singer says, possibly repatriated to shareholders. That's a haul many would no doubt cheer.

Vincent Ryan is a senior editor at CFO.


What CFOs think about the future of financing; responses from a July 2009 CFO magazine survey


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