|A monthly eNewsletter on leveraged finance||December 2008|
Tight credit markets continue to impact a borrower’s ability to raise new capital for debtor-in-possession (DIP) and exit financings. Despite the extraordinary steps by the U.S. and European governments to provide stability and liquidity in global financial markets, banks and other financial institutions continue to hoard cash and U.S. dollars instead of lending to credit worthy borrowers. Lenders, borrowers and turnaround practitioners are trying to make sense of it all and identify the market inflection point and return to normalcy. How will we know when the grim credit market picture begins to brighten? Here are five indicators to watch.
Primary Debt Market
Nevertheless, the primary market remains open for business on a limited basis. Investors are focused on leverage in addition to structure, pricing and borrower credit quality, making it harder for banks to place and determine a market-clearing price for tougher asset-based deals.
Buyers of this paper are typically hedge funds and pricing for this tranche will be well north of the first-out tranche. Typically, the facility is documented as a single class of debt under a single credit agreement that eliminates the need for an intercreditor agreement. Eliminating the ability for this tranche to become a fulcrum security in the event of a subsequent restructuring provides real value to the borrower and mitigates the impact associated with a higher LIBOR spread.
Rising number of Defaults
1. Improved secondary trading spreads--particularly for 2008 vintage deals. Throughout the fourth quarter 2008, overall secondary spread levels skyrocketed to all time highs. By contrast, post-close trading levels for the 30-35 deals completed in 2008 have generally traded 5 to 8 points higher than the overall market. The difference is in part driven by relative value, with pre 2008 deals priced significantly lower than current transactions. Additionally, 2008 deals are characterized by higher ratings, tighter financial covenants, lower leverage and smaller deal size. As the market begins to stabilize, look for these credits to trade closer to or above original issuance levels. Once investors can again point to higher post-close trading levels, they will likely begin to invest new capital in the primary debt markets.
3. Relative stability in the $55 trillion credit default swap market. The cost of default insurance has risen dramatically, driven largely by the lack of transparency and clarity around which counterparties are deemed to be credit worthy by investors. As the cost of these “insurance” policies begin to decline, this will likely be a leading indicator for improved investor confidence.
4. A strengthening commercial paper (CP) market. CP is a critical source of short term financing for companies across all industries. Government actions to stabilize the CP markets should lower short-term borrowing costs while removing illiquidity risk for the thousands of companies who access the CP market for their daily cash flow needs.
5. Reduced LIBOR. Overnight LIBOR rates between banks have been volatile with 2008 rates as high as 6% in late September vs. levels seen as recently as July of 2%. At yearend 2008, three month LIBOR rates have decreased to 1.9%, approximately 100 basis points below levels observed prior to the collapse of Bear Stearns in March 2008. Governments from around the world have been pumping seemingly limitless amounts of cash into the financial system to improve liquidity. The markets are cautiously awaiting signs that the large commercial and investment banks have resumed their normal lending practices. This should help normalize 3-month LIBOR rates, which historically trade within 10-20 basis points vs. the Fed funds target rate.
Restructuring opportunities arising over the next several months will likely remain challenging, especially for relatively weaker credits. Investors are largely expected to remain risk averse until clear data points emerge from the government’s unprecedented efforts to restore normalized market conditions. Let the market thaw begin…
Thomas Miele (firstname.lastname@example.org) is senior vice president, GE Capital Markets, Inc. and focuses on syndicated finance for General Electric Capital Corporation—one of the largest secured lenders in North America. gelending.com