NEWSLETTER DECEMBER 2011

KPMG LLP (UK)

Debt Side Story

Leveraged logjam
Companies approaching leveraged refinancing throughout the autumn months have continued to experience difficulties in accessing debt markets, which have exhibited illiquidity and volatility.

Well advanced refinancing preparation will continue to be key to placing borrowers on the front foot for refinancing discussions.

The autumn has been a volatile period in global financing markets, with the ongoing Eurozone concerns looming large. In this issue we have covered a handful of current market trends.
Eurozone contagion
The Eurozone debt crisis has been a central focus for all forms of media and bar room discussion over recent months. Recent visible impacts have included: Continental sovereign downgrades; bank asset writedowns; acutely reduced interbank lending; and heightened investor uncertainty. These symptoms have resulted in many banks experiencing difficulties, both with their own funding position and their capacity to lend in advance of the arrival of US$ 2 trillion of maturing European corporate debt in 2012. We have recently seen certain European banks reducing US dollar lending books, driven by reduced inward funding from US institutions. Moreover, limited and more expensive access to capital markets and increasing regulatory capital requirements are increasing the cost of bank funding, restricting the flow of credit to the real economy. Efforts to resolve the sovereign crisis and to stabilise funding markets are still underway as we head towards the end of the year, and all market counterparties remain cautious.

This current logjam prevailing in the leveraged loan market has been driven by a combination of a loss of confidence due to the sovereign debt crisis and transaction structures signed earlier in the year being more aggressive than the current market would allow. Such structures have resulted in a level of off-market debt still held by underwriting banks which was expected to be sold into the institutional loan and high-yield bond markets. Purchases of such debt have been incentivised through increased discounting, upwards flexing of pricing and restructuring of terms over recent weeks. Discounts on loans offered by selling banks have been seen as high as 9% of nominal value. With the current economic downturn remaining, it appears that the leveraged logjam will subsist into the near future. Well advanced refinancing preparation will continue to be key to placing borrowers on the front foot for refinancing discussions.

...consider their funding strategy for 2012 with an eye to syndicate composition, refinancing timetables and the need to diversify funding sources...
Thus as we watch the eurozone crisis unfold, there is much food for thought for borrowers, who might take a moment to consider their funding strategy for 2012 with an eye to syndicate composition, refinancing timetables and the need to diversify funding sources.

Debt Side Story / December 2011

Going back to forward starts

The European loan markets have recently seen a re-emergence of the forward start facility (FSF), a product last prevalent in the market in early 2009 in an environment of severely restricted liquidity immediately following the collapse of Lehman Brothers. If some lenders within a syndicate will not grant a maturity extension or a refinancing process is deemed to have too high an execution risk at a point in time, the FSF allows borrowers to maintain their level of existing facilities through to maturity, while securing an amount of extended maturity funding, albeit at a reduced level. FSFs are separately documented facilities, committed from signing, but only available on prepayment and cancellation of the existing facility. Current lenders who are rolling over receive mark-to-market pricing on their commitments under the FSF , providing a yield reflective of current market conditions. Existing lenders not participating in the FSF receive no uplift, but their original commitments in the existing facility remain in place until maturity. Given the current lack of liquidity in the market and inherently volatile pricing atmosphere, it is not surprising that borrowers and lenders alike are reconsidering these structures. Recent examples include UK residential firm Grainger Plc, Italian construction firm Astaldi and Spanish utility Endesa.

Ancillary business Empty your wallet?

Whilst ancillary lines have always been important for a borrowers relationship bankers, these additional facilities are increasingly driving the appetite and participation of lenders. Borrowers should not underestimate the importance of their ancillary requirements and spend when deciding how to divide business between their syndicate and appropriately incentivise their relationship banks. At the larger end of the market, the incentive of future advisory or capital markets business is increasingly a prerequisite for sourcing competitive terms and at the smaller end, hedging, deposits, cash management, leasing and even corporate credit cards can make the difference for potential lenders.

Premium Bonds
Following a six week slowdown in issuance over the summer months, the European corporate bond market has shown some signs of life in recent weeks; however entrance to the market is coming at a price. The market has started to find some momentum in the last couple of months, with some issuers reacting to an uncertain tomorrow by choosing to issue into already turbulent markets. Successful issues in this period have generally been from established, well liked names and have been characterised by new issue premia. In more benign market conditions, new issues would generally be priced based on the secondary curve (potentially with a small new issue premium). In the month to mid-October however, new issue premia for European A and BBB rated issuers were averaging c.20-55bps. Some issuers even paid a more extreme price to secure funding; Enel (A-), an Italian utility was estimated to have paid a premium of c.70bps on top of its pre-announcement spread for a bond issued on 21st October. However, spread isnt the only factor to consider in these uncertain times as basis costs remain low. Issuers will consider these market conditions in the context of their funding and timing requirements and should maintain a nimble approach and be positioned to access windows of market availability as they open.

Basel III pricing models are becoming increasingly reliant on ancillary returns to ensure margins remain competitive.
The lack of ancillary business is a particularly pressing issue in the current environment given the impact of increasing regulation on banks return requirements. Basel III pricing models are becoming increasingly reliant on ancillary returns to ensure margins remain competitive. The worrying thing for borrowers is the disconnect between the ancillary haves and have nots. The market might benefit from a two tier structure, allowing smaller lenders to participate at margins that meet minimum hurdles whilst the traditional ancillary banks fight it out for a more keenly priced tranche with embedded benefits. In the meantime, borrowers can expect to see continued disparity between lenders in refinancings.

In the next edition of the Debt Side Story... On Credit Watch EU proposals on credit rating agencies .

KPMG Debt Advisory has a long track record of providing specialist, independent advice across the full spectrum of debt products and markets. If you want to know more, please give us a call.
Neill Thomas Partner, Corporate Finance T: +44 (0)20 7311 4757 E: neill.thomas@kpmg.co.uk David Reitman Partner, Corporate Finance T: +44 (0)20 7694 3113 E: david.reitman@kpmg.co.uk Peter Bate Director, Corporate Finance T: +44 (0)20 7311 8307 E: peter.bate@kpmg.co.uk Simon Mower Manager, Corporate Finance T: +44 (0)20 7311 8967 E: simon.mower@kpmg.co.uk

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