Q&A: RBC Takes the Holistic Approach
September 17, 2009
Changes in the world of corporate debt have led banks to take a more holistic approach when working with high yield issuers and even some investor clients. Underwriters like RBC Capital Markets are, for example, offering traditional loan clients on both the buy and sell sides of the market senior secured bonds. RBC was a top five managing underwriter for North American syndicated loans for the first half of 2009, and over the last year has expanded its leveraged loan and high yield sales and trading teams with veterans of Citi, Bank of America Merrill Lynch, Morgan Stanley and others.
Leveraged Finance News spoke with RBC’s Jim Wolfe, head of U.S. leveraged finance, and Miguel Roman, U.S. head of global syndicated finance, to ask how their group is adapting to the changing financial climate.
Leveraged Finance News: We recently covered the development of loan players getting involved in secured bonds. How has RBC adapted to this?
Roman: It is a fact that the senior secured bond market is becoming a substitute for the loan market. It’s a very integrated discussion at every opportunity, so that we can go to clients and advise them on what is the optimal way to fill the senior secured piece of the capital structure. Is it the loan market? Is it the bond market? And there are pros and cons and there are … a number of variables that come with that decision. … On the investors’ side … we’re showing loans and bonds, whereas ordinarily we might have an investor looking at just loans. We’ve been able to place bond paper with traditional loan accounts … there’s that cross fertilization that’s happening on the investor side as well.
Miguel Roman
Wolfe: One of the phenomenons you’re seeing is that the high yield market has rallied so much that the price differential between senior secured notes and term loans has narrowed, so the price differential relative to flexibility… isn’t as costly as it had been historically. For example, in May we were a joint bookrunner on a $400 million bond deal for a data-hosting business called Terremark, and we structured that as a senior secured note deal, really because given the company’s cash flow profile there was a real premium from their perspective to have flexibility with covenants. And that ability to access the markets … led them to the bond market as opposed to the loan market.
Are you gearing up for a return of the leveraged loan primary market?
Wolfe: The loan market is open, it’s just a question of how many dollars you need to extract from the market. As you get to $300 million plus you have to think about capacity. For example, we completed in July a leveraged buyout for a company called Earthbound Farms that HM Capital Partners bought, which was $195 million total in financing. There was roughly $110 million of a term loan and the balance in mezzanine. That’s of the size—in that $125 million to $225 million range—that we feel that can get placed successfully in the loan market. As you get to bigger numbers, it becomes questionable in terms of market depth. We continue to be active in the loan market, but as you look at bigger deals there are still liquidity constraints.
Roman: We just closed an add-on to a tech-related company that does data storage called Switch and Data. We did an add-on of over $100 million in the form of a term loan that came in on terms that were attractive to the issuer, and we oversubscribed the deal. In the mid-market space it is feasible and possible to attract good rates relative to where they were three months ago. It’s when you get to bigger sizes that you see that the market is not back to the condition it was in two to three years ago.
The high yield primary market has remained active this year. Do you expect that momentum will continue through the rest of 2009?
Wolfe: We started off post-Labor Day very strong on new issuance. The fourth quarter will be strong as well, but investors, just given returns to date, can become selective as we head towards the end of the year. At some point, they’ll want to take a breather given that it’s been such a busy year. Nothing out there leads us to believe that the market is going to go through any correction. It’s just a question of potential push back from a pricing perspective as supply and demand become more balanced.
Jim Wolfe
What trend or development in the credit markets this year has surprised you the most?
Wolfe: As we sat here a year ago, and it felt like the world was coming to an end when Lehman blew up, our view was that it was going to take a year for both the economy and the credit markets to sort themselves out. We saw a snap back very quickly from the high yield market, and so the speed with which the market came back [was what surprised us the most]. … To some extent the technicals are ahead of the fundamentals. In many sectors, the underlying performances of companies continue to be very challenging.
Roman: I would add that we’re still in a world of haves and have-nots in the sense that certain sectors, the more stable and noncyclical, are in favor, and investors are starting to embrace them with quite a bit of enthusiasm. Certain other sectors, investors are still very reluctant to commit dollars to. So depending on the sector or the quality of the company, the world is looking a lot better over the last 90 days than it used to.
Do you think high yield spreads are where they need to be? What do you expect for the rest of this year?
Wolfe: You’ve seen a dramatic decline in spreads over the last year, and they’ve continued to tighten. We’re at the point now though that it’s going to be more economic driven, with spreads continuing to tighten as we see some improvement in underlying fundamentals. … You’ll continue to see some improvement in credit spreads, but investors, despite the fact that on the high yield side things are very liquid, still have narrow return thresholds. And it’s very credit specific.
What do you see as the most important developments taking place right now related to the speculative-grade credit markets?
Wolfe: We’re in a period where there’s still a valuation gap between buyers and sellers. One of the biggest trends we’ve seen is that gap narrow in the last couple of months. People’s valuation expectations have changed. … The other phenomenon we’re seeing is corporates really focusing on their core business and beginning to shed noncore assets. …We’re looking at something in the defense space involving a large corporate divesting of a noncore asset. That can have a huge impact both for leverage of the company and the high yield market.
When do you see LBO transactions beginning to take a bigger share of leverage finance transactions?
Roman: There has been a scarcity of LBO activity. … Part of the reason is the valuation gap between buyers and sellers. The other is that financial sponsors are hyper-focused on their portfolio companies, making sure they address any issues with those, and so there have been some distractions. Another important reason is there was a perception that there was no financing available for it. We have seen in the last quarter or two a bit of a reversal of all those trends where sponsors are trying to look at opportunities.
What do you see as the biggest risk to a continued economic recovery?
Roman: We’ve got to hope that the consumer does not retrench or we’ll see a dramatic reduction in the ability of consumers to keep the economy going, which is why we’re in the recession we’re in. We’ve got to hope that consumer confidence and their pocketbooks recover to the point that economic activity and hope for recovery stays on track. … The consensus is that we’re coming out of the recession in the next quarter or two, and the key risk there is the U.S. consumer holding up their end of the bargain.
If there was one thing you could change about the leveraged finance market today, what would that be?
Roman: We would love to have a lot more money flowing into it, especially on the loan side of market. We’re still a long ways away from the kind of health on the leveraged loan side that we would like to see. We’d like to see a lot more money flowing back into the market.
Wolfe: There’s a saying: Leave it to Wall Street to ruin a good thing. It’s going to be important, as we come out of the cycle, that people remain disciplined and don’t let companies get to the excessive leverage levels we got to before.
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