Another One Bites The Dust: The Perils of Debt Syndication

I previously highlighted the perils of leveraged debt syndications. Another recent failed transaction is Veritas-the seventh broken Euro high yield deal this year. Veritas is a large complex cross border transaction. At $8B it is the largest LBO in 2015. Carlyle and GIC (Singapore’s sovereign wealth fund) agreed to purchase Veitas, Symantec’s data storage unit, in August. The deal takes place in a year in which private equity has faced high purchase prices due to competition from strategic acquirers. Thus, Carlyle likely paid a full price for Veritas.

Some details of the deal are as follows:

1)     Debt Underwriters: Bank of America, Morgan Stanley, Goldman Sachs, UBS, Jefferies, Barclays, Citi, and Credit Suisse.

2)     Original Financing Package: $2.45B term loan, Euro 760MM term loan, $500MM secured notes, and $1.775B unsecured notes. Both term loans were covenant-lite.

3)     Revised Financing Proposal (because the original failed): $1.5B term loan, Euro 760MM term loan, $700MM secured notes, and$700MM retained by the underwriters-never a good sign of the deal’s strength. Both term loans are covenant-lite.

4)     Leverage: giving full credit to pro forma EBITDA improvements yields leverage of 4.5X for the senior and 6.5X total debt. The trailing unadjusted EBITDA leverage is higher. Even at 6.5X pro forma, the level will raise regulatory concerns as it exceeds their 6X threshold. The issuer is rated B/B2.

Investor concerns include:

1)     Size: largest deal of the year.

2)     Business Risk: data storage and cloud uncertainty suggest high business risk.

3)     Leverage: see above.

4)     Difficult to Analyze: divisional buyouts are always hard to evaluate. You are concerned with historical parent cost allocations, and whether the standalone unit can operate as an independent business. Usually underwriters require a forensic accounting review, which is shared with potential investors to give them comfort regarding historical performance. The review reconstructs the historical financial statements. For some reason that was not required here. No wonder investors are reluctant to commit. How can you build reliable reliable debt service models off of unaudited divisional financial statements?

I don’t think the market is losing faith in leveraged debt. Rather this appears to be a poorly structured deal agreed to before the mid August correction by aggressive underwriters trying to win a prestige assignment. Sometimes you have to be careful about what you wish for as may just get it. The underwriters are now getting it.

J

Leveraged Lending Envy: Banks and Non Banks

Bankers and their supporters continue to object to regulatory leveraged loan leverage limits. The limits raise concern whenever transaction related Funded Debt to EBITDA ratios exceeds 6X. The usual complaints include:

1)     The Market and Bankers know what is best-not regulators

2)     Regulators are keeping banks from lucrative lending opportunities

3)     The lucrative opportunities will be picked up by less regulated non banks like business development companies (BDC)

4)     The restrictions are inhibiting the LBO market development and growth

Let’s take a look at these complaints:

1)     Market knows best: The tragedy of commons shows that some market equilibrium can lead to suboptimal results. Look at the concentrations(leveraged loan commitments YE 2007):

Merrill: $97B

Citigroup: $97B

JPMorgan: $95B

Goldman: $95B

2)     Loss of lucrative loans: lucrative loans usually have more risk than acknowledged. Consider leveraged loan 1Q08 provisions and charges for some of the major players:

Merrill Lynch: $1B; contributor in its forced sale to BofA

Citigroup: $2.6B; contributor in its subsequent failure and rescue

BofA: $700Mln; contributor to its need to be rescued

JPMorgan Chase: $1.4B

Wachovia: $500MLn; contributor to forced sale to Wells

3)     As I previously discussed-this is really a work in process whose outcome remains to be seen. Nonetheless, just because someone else is doing something stupid doesn’t mean tax payer guaranteed banks should follow them off the cliff. Private capital not subsidized by tax payers should be free to invest at whatever leverage levels they chose. Furthermore, bankers seeking BDC lending flexibility should keep in mind it comes with BDC capitalization levels which have substantially less leverage than banks. Sorry boys, you cannot pick and chose the good BDC features without taking the bad.

4)     Restricting the LBO Market: PE may complain that the restrictions reduce the availability of under priced bank loans. The response- is that so bad? Also, remember the restrictions focus on leverage greater than 6X. If you need more than 6X to make the deal work, then maybe the deal is overpriced.

The leveraged loan market, like other deal markets, such as real estate, is prone to boom and bust cycles. Lenders fixate on nominal not risk adjusted return as they are driven by incentive compensation to maximize their bonuses. Regulators trying to stop them face the same plight as someone trying to stop an individual from playing Russian Roulette who is on a winning streak. When that individual is subsidized by tax payers, as banks are, then it does not seem too much to ask to place some restrictions on leverage levels. The banks should be thanking the regulators for stopping them from hurting themselves.

J

Big Banks, Leverage and the Smell Test

Federal Regulator's recently proposed tougher regulations for eight banks.  Will it hurt the economy?  Lobbyists for these banks think so.  My colleague, Joe Rizzi, says 'Not so fast'.  Read his interesting article that appeared in  the American Banker last week regarding Big Banks, Leverage and the Smell Test.