Aussie borrowers: Keeping it liquid

At a roundtable discussion co-hosted by the Commonwealth Bank, key borrowers discuss liquidity in the Australian syndicated loan market.
Dale Bridle, group treasurer, John Fairfax Holdings
Linda Laznik, group treasurer, The GPT Group
Phil Wallis, manager funding & investments, Telstra Corp
Andrew McGregor, head of debt advisory, AMP Capital Investors
George Confos, general manager, institutional lending solutions, CBA
Loretta Venten, general manager, loan markets, CBA

The liquidity crisis has failed to halt the flow of money into the Australian syndicated loan market - one of the few markets open to issuers over the period of dislocation. The relative stability of that market drew three major borrowers - Wesfarmers, GPT Group and Macquarie Bank - to fund a total of A$21 billion ($19.3 billion) in the syndicated market during the crisis, a stunning testimony to the stable pricing and terms of that market.

On October 31, Commonwealth Bank of Australia and FinanceAsia jointly hosted a roundtable discussion featuring four key Australian borrowers to discuss their key funding drivers during the crisis and developments in the syndicated loan market.

George Confos:Although pricing in the syndicated loan market has moved out, it has not widened to the huge extent it has in the bond market, primarily because pricing had not tightened in the loan market to the degree
that it had in the bond market. Consequently the loan market has experienced relative stability in terms of pricing and volumes over the period of dislocation.

What drove you to access the loan market?

Dale Bridle: Fairfax accessed three markets to fund the acquisition of Rural Press. The deal provided our first opportunity to get a broad cross-section of debt investors into our portfolio as we had traditionally been a bank borrower and a US traditional private placement (USTPP) borrower. We raised A$2.1 billion û via A$1.2 billion in the Australian loan market, split between threefour-, and five-years; a US$250 million USTPP; and a euro350 million eurobond. The opportunity in the local market was to broaden our bank group. We traditionally had a core bank group, but with the company trebling in size over three years, we wanted more opportunities to grow relationships.

Phil Wallis: Telstra executed a A$1 billion fiveyear syndicated bank loan in October and we received surprisingly strong support, considering the severity of the liquidity crunch û we were twice oversubscribed with a good spread of domestic and offshore banks, including a couple of new names. We had around A$2.6 billion in long-term debt to raise this financial year. The credit
crunch hit in August and September and left us with few viable funding alternatives. The loan market exhibited key advantages over the period of liquidity crisis when the bond markets shut down and couldnÆt price anything. The syndicated loan market offered a relatively stable pool of capital that provided certainty of execution, timing, price, covenants and access. It also provided reputational protection. A loan transaction is a private deal û you arenÆt exposed in the same way you are in the public bond market if things go wrong.

If the bond market continues in a state of flux, will you consider returning to the syndicated loan market?

Wallis:We would look at it û but we would examine the comparative pricing and volume closely in relation to the bond market alternative. I am not expecting the bond market to remain closed next year. If that was to happen we could go back to the loan market, but the loan market practically dries up after five years, and we require quite a bit of longer-term funding. So itÆs unlikely our funding objectives could be entirely satisfied by the loan market.

Linda, GPT recently successfully executed a euro 2.01 billion syndicated facility raising one-, three- and fiveyear tenors. You had a bridge maturing and a relatively short debt maturity profile û why did you decide on the loan market?

Linda Laznik: It was a tough decision at the time, given when we started considering a deal the issues with liquidity were beginning to be felt. We were a bit nervous about the volume, but feedback from the market was very positive. We spent the first half of the year looking to fund through the euro mediumterm note (EMTN) market. We began that programme in April and then went to Europe to meet with investors. We were hoping to get that away, but events overtook us.

We would have always done another syndicated deal, but maybe not in the volume we eventually did, because we couldnÆt get that EMTN issue away.Andrew, have you looked at running competing bonds versus bank market
solutions for your funding needs?

Andrew McGregor:We have run bank and bond solutions against each other in the early phase of some of our acquisitions. To be confident that you will have a bond solution at the right time for your acquisition you need a very clear process and timetable. You need good information flow and you need to be very confident that your bond underwriters will definitely be there.

As a result, we predominantly use the bank debt market to support our acquisitions. That is driven by the fact that most acquisitions arenÆt on a clear timetable. There are many changes as you work through the process. In the capital markets you tend to work more closely with your bond underwriters but you also have to prepare the marketing material and program to go out with it, which you may not always have time to do during an acquisition.

Confos:With acquisition funding, when you are buying a public company you need the flexibility from the banks to have funding available. You need to be able to keep it open in case issues do arise which may impact timing.

Dale, you faced that issue with the acquisition of Rural Press, didnÆt you?

Bridle:With a scheme of arrangement you have far more certainty. But with us, the choice of funding market comes down to diversity and tenor. One of the disappointments of the local bond market is that you canÆt go beyond five years at an economic price. And banks certainly havenÆt developed the seven-year syndication market for a triple B credit.

We were forced to go offshore in 2003 to the USTPP market. We raised 10-, 12- and 15- year money because we couldnÆt get tenor onshore, and that is still the case. The banks here remain at a competitive disadvantage beyond five years.

Why is there such a mismatch between investors' and issuers' pricing
expectations on longer maturities?

Wallis:On the bond side, lack of confidence is the issue. Australian investors tend to take the lead from offshore markets rather than operating independently. We have looked at the domestic bond market regularly over recent years and found investors were reluctant to commit to volume and price without a recent offshore benchmark to refer to.

ItÆs not a structural issue, itÆs more about the smallish size and isolated nature of the domestic bond market û they simply donÆt see enough deal flow to confidently price corporate credit competitively.

Bridle: That is particularly disappointing for an A-rated credit. I could understand it more if they were dealing with a triple B credit, but for a credit like Telstra they should have a domestic curve that goes out beyond five years.

Wallis:We do have bonds out to 10 years, but the local market wonÆt price or support that kind of transaction unless it comes hard on the heels of a eurobond or 144A issue. The domestic market is taking a much lower proportion of our A$ deals. Only 30-40 per cent goes to domestic investors û
the rest goes offshore. The local market appears to be contracting for Australian corporate credits.

The Australian loan market investor base is dominated by banks rather than
institutional investors. Is this a positive?

Wallis: It is a benefit when other markets become disorderly. The loan market is a separate pool of capital with its own dynamics and price drivers. It operates quite independently of the bond market in a semiregulated
environment and is nowhere near as volatile.

Bridle: The few issuers that have gone out to seven years have found their deals have tightened so aggressively on launch that it gives us no faith in the bond market. You donÆt want to launch at 76 basis points and list in the mid-60s two days later. That has happened in the past, therefore we canÆt take that risk. If credit is not priced correctly we cannot go to that market.

Andrew, you have executed a number of infrastructure deals. Do these types of deals offer the bank market the best opportunity to get more comfortable with longer tenors?

McGregor:We have had acquisition underwrites on straight bank-debt term loans out to past 10 years. That deal was unrated û but was akin to a triple B minus. One of the differences was the size û these have been relatively small deals. We do see much more opportunity to go out û seven-year bank debt is pitched quite often, but generally as a single tranche of a bigger transaction.

On the bond side we have written many deals past seven years in the domestic market. We did a deal earlier this year past seven years û participation was mixed 50:50 between onshore and offshore investors. We have also been involved in some securitisation deals, one which was banked entirely by domestic
investors which went out to 27 years û but it was under A$200 million.

Confos: Three years ago the future for the loan market looked dark because corporate Australia was strong and underleveraged. Three years on, the stock market has taken off, so the number of acquisition bridges has sky-rocketed. ThereÆs an amazing correlation between the movement in the All Ords and the movement in the syndicated loan market volumes.

For any major acquisition, a bridge followed by a loan or bond takeout has
become the norm. The pricing on bridges has contracted far more than on five-year pricing, interestingly with the exact opposite happening over recent months.Dale, were you satisfied with your bridge pricing and the process on Rural

Bridle: Yes û the process was flawless. We didnÆt face the challenges Telstra did because all the markets were open when we executed our deal. Our bridges were paid back quickly û they were priced ridiculously low.

Has the liquidity crisis permanently changed your funding strategy?

Wallis: The current dislocation appears to be temporary. The markets will return to normal and unfortunately also probably go back to the same bad habits which created the current crisis. We donÆt anticipate any permanent
change to our funding strategy which relies on funding via the global bond markets.

The loss of confidence in the asset-backed commercial paper (ABCP) markets, which shut down money markets, is abating now. There seems to have been no major underlying economic damage although certain financial institutions and investors have taken a battering and could be slow to recover.

One unique feature of this liquidity crunch was the fact that is was predominantly a bank problem. Banks had to suddenly re-finance their conduits and structured vehicles using their own balance sheets, resulting in the need to expand their capital base and raise cash quickly.

Consequently the interbank money market shut down, which had knock-on effects on everything else. The closure of the interbank market was unusual and disturbing, weÆve never seen that happen before.

Fortunately central banks responded by flooding the system with liquidity, removing uncertainty and helping bond markets gradually recover confidence.

Bridle: The Reserve Bank of Australia managed the problem brilliantly. They could see what would have happened if liquidity had remained frozen in the interbank market and they managed the problem very well. Provided they remove that liquidity in due course the market will stabilise quite quickly.

Wallis: Credit is just as good as it has always been but the bond market has not been able to re-establish new pricing benchmarks.

The CDS market isnÆt reliable, the secondary market isnÆt turning over much
paper and there have been very few new issues, even though there is a huge backlog in the pipeline.

Will anything change in terms of your percentage of exposure to CP markets?

Bridle: I wouldnÆt be exposed to the CP market. If you have a large book the risk is bigger. But to make it economic, to have the standbys well priced, you need a large book. It is an accident waiting to happen and this
accident was bigger than most anticipated. So anyone who was caught short trying to fund CP got what they deserved.

Wallis: ABCP was mispriced for certain types of issuersû the risk was not appreciated. Investors had become very complacent û buying CP issued by SIVs with poorlyunderstood assets such as sub prime mortgages and CDOs.

Having said that, CP forms a core part of our funding as it remains cheap, flexible and up until recently, reliable. Obviously the refinancing risk has been highlighted but we will continue to manage this by having a spread of CP programs in the $, E, $A and $NZ.

Apart from money, what did you want from your bankers throughout the crisis?

Wallis:We basically wanted them to be there with funding when we needed them. Some of the European banks shut down entirely; they had no appetite for lending. The Australian banks were in much stronger shape than some of their offshore counterparts.

Did you find the international banks very open about what was going on?

Wallis:No û they just basically said, we canÆt lend you any short-term money. The reasons were obvious û they were having trouble funding themselves and they didnÆt want any more assets.

McGregor: Our experience was mixed on the term side. We were right in the middle of an acquisition in late June. We found a few US, European and Asian banks who were very open about the issues they had to overcome if
we were going to be working with them on the deal. Other banks in the same regions had no issues, however we did move their pricing in line with those others. ThatÆs where we benefited from having a broader range of banks involved in the deal.

Bridle:We priced our USTPP in the third week of June: the crisis was just 10 days in. Investors were very nervous û but it didnÆt help that we also announced an acquisition. Given an opportunity they would certainly have gouged us for another 30 or 40 basis points because they could see the publics
moving out.Is it possible to bring more institutional investors into the bank debt market?

Wallis: It would be hard because the bank loan market prices off its own internal bankspecific criteria. Fund managers have different investment drivers and bank loan participation would have limited appeal. I think they will remain distinct segments of the capital markets.

Bridle: We donÆt allow that. We lock investors in on a take-and-hold basis. You donÆt know what is around the corner. If you are committing to borrowing from a bank for five years I want them to stand with me for five years.

McGregor: Even with substitution clause and right to sell, the main reasons you choose a loan is the flexibility, and that flexibility doesnÆt necessarily suit institutional investors. They prefer non-revolving deals
and non cap-ex facilities. That is why the bond market is more suited to their
investment process. It also allows them to match assets and liabilities. Our domestic bond market will be restricted to certain tenors because of the way that they want to match their book.

Would the bond market develop more if there were covenants?

Wallis: We donÆt mind giving change of control clauses or event risk protection if required but we do not accept financial or operating covenants as bond investors are paid to accept this credit risk.

Bridle: I prefer not to give covenants to the bond market. For the first time we gave away a change of control clause and a step-up in our USTPP and the euro-denominated deal because it was mandatory.

In the loan market, do covenants attract a significant price break?

Confos: Yes û they are vital from a syndication point of view. They are critical from a rating and price perspective. For example, in most banks you get a different security value if you are covenanted, which translates into different pricing levels. Basel II introduces much more sophisticated return models, so if you have high security values and good covenants it will be
recognised. Banks will also hold relatively more if covenants are strong.

McGregor: We do a lot of project finance deals. In some instances covenants can be too restrictive and actually prevent you from running your business in an efficient and effective way. Nine times out of 10 the banks
donÆt mean to do that, but there is an education û or negotiation û process
required. Our clients donÆt want to be micro-managed.

We have used covenant packages to help structure around issues financiers have had with their credit review of a project. When a financier has had concern, and we know that concern should not be there, we use our covenant package to add protection layers around whatever element troubles them to enable them to participate in the deal, This may then bring down the price of the deal to compensate for the additional protection. It might not give us a pricing break; it might give a yes-no response. But if the financier goes ahead with the deal, it can create a pricing break across the spectrum of the transaction.

We pay a lot of attention to how our covenants are structured for that reason. We start every single deal with a standard boilerplate term-sheet and then we find the structure that fits best for each client and the banks pitch on the pricing.

Bridle: There is another way of doing it û you find what the deal is worth in the market, you put the pricing in and then you gauge demand.

McGregor: We have done that as well û it depends on the client and what they are looking for. Some clients just want the best price, regardless of investor diversity.

Bridle: In triple B territory, covenants are very important. Your lenders donÆt want to wake up one day to find that you have blown your
balance sheet and are no longer investmentgrade if they have no triggers.

McGregor: You have a lot more flexibility when you are rated A as opposed to triple B û itÆs not just about pricing, itÆs also about magnitude of hold.

Is covenant-lite dead in the water in the syndicated loan market?

Bridle: That structure will be the catalyst for the next crisis. If you can lever up an industrial seven to eight times Ebitda and you have a covenant-lite deal at senior, you are heading for trouble.

Loretta Venten: Some covenant-lite structures are only tested if you are going to do something else û you donÆt have ongoing protection.

Wallis: One key outcome of the liquidity crisis is how it has affected the way we approach banks for pricing. In a normal market we would have used a tender process, but in this market, because of the uncertainty, we went with a fixed offer price. That cuts down risk and gives some leadership to the deal.

Bridle: I prefer that process in any market environment. It gives certainty to the deal and indicates you know where your credit should be priced.One of the implications of the leveraged loan frenzy was the number of secondary market desks emerging û we now have secondary market desks in Asia and specialised secondary market information systems. They have both leveraged and corporate names on them. Does this concern you?

Wallis: It doesnÆt concern me because we are only in the loan market on an irregular basis. We would like to be consulted before someone transfers, but we canÆt withhold our consent. We arenÆt concerned if the pricing and covenant package suits us û who holds that debt doesnÆt really matter to us. This attitude probably reflects our bond market background, where debt instruments are readily negotiable.

Bridle: When you are an A-rated credit it is not really an issue; but if you are a triple B or triple B minus it is, even if you just want a
simple change of covenant. In 2003 we changed our covenants when we moved our
debt to Ebitda from a maximum of 3.5 to four û an innocuous change in line with
industry standards. To have to go through those investors is very difficult û it restricts your corporate flexibility in terms of how you structure your balance sheet.

A number of unrated corporates û like OneSteel û successfully tap the
syndicated loan market and the USTPP market. These markets have the volume, pricing and maturities corporates want and they donÆt have the rating agencies hovering over them. As debt funding grows, is it inevitable they will have to get a rating?

Bridle: WeÆve chosen to have a reasonably good relationship with S&P and weÆve been very open. As those unrated companies grow and diversify, theyÆll have no choice but to seek a rating or else they will remain locked
into banks.

Wallis: Investors need the rating û they cannot easily price and compare the credit risk without them. Ratings are essential for the smooth functioning of the traded debt market.

McGregor: Every deal we do starts with the question, do we need a rating? We then structure around that point. We can be driven by the ability to tap the credit wrappers. In the last 18 months the ability to transact a negative basis trade through the use of a monoline insurer getting triple B all-in spreads of sub 50 means we might rate something because the monoliners require two ratings. Otherwise we might be happy to do deals without a rating.

Laznik: The rating was critical for us because of the volume of funding we required and the diversity of funding sources we were seeking. In August we
were placed on negative outlook but the rating agency issues were mainly around
liquidity and I didnÆt get any comments from the bank group.

Bridle: If we think an acquisition will have a material impact on the balance sheet we deal with rating agencies. Sometimes weÆve got a full rating review; sometimes weÆve just had informal discussions û when weÆve take the view that the change to gearing is temporary or not material to the rating.

Confidentiality is a big issue in some acquisitions. Is that the key issue for you?

Bridle: In a scheme of arrangement there is no issue because there are no secrets. All the information was public. We communicated our strategy clearly and well in terms of the number of banks we wanted; which banks we wanted; and which banks we didnÆt want. We chose to have a fixed number of banks rather than a larger bank group with slightly tighter pricing. It
was a conscious decision to have 8 to 10 banks rather than 15 to 20. IÆve seen too many banks come and go from the market û the banks in our group are here for the long term. Other corporates have taken a different view û they let the volume of banks and demand drives the price.

But when you are making a private bid, as we did for the INL Publishing business in New Zealand û confidentiality can be a big issue. We did that on a no-names basis. We told our banks we were making an acquisition for NZ$1.2 billion that was in our space. We showed them what our credit profile post-transaction would be and then asked if they wanted to fund it. I trust the banks implicitly, but why have a wider group that needs to know what you are doing?
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