Australia Junk Loans Made in U.S. Surge to Record on High Yields
Australian companies borrowed a record $6.2 billion from high-yield investors in the U.S. since October as the lure of loans with looser terms offsets higher borrowing costs.
Fortescue Metals Group Ltd. (FMG) increased a loan to $5 billion from $4.5 billion after failing to syndicate the facility among Asian banks. One meeting with institutional investors in New York helped Nine Entertainment Co., rated Ba2 by Moody’s Investors Service, seal a $735 million transaction. Asia-Pacific borrowers have never raised funds from speculative-grade U.S. loan investors on such a scale, according to sale arrangers UBS AG and Credit Suisse Group AG.
North American asset managers, facing a fifth year of near- zero benchmark interest rates, are buying into the high-yield loan market at a record pace. The funding, which doesn’t require regular balance sheet checks and has maturities as long as seven years, is attracting borrowers as an exodus of European lenders and heightened banking regulations damp liquidity in Asia’s bank debt market.
“It’s not purely about the interest cost,” said Simon Kelly, chief financial officer of Nine Entertainment, which is paying 7.25 percent on its new debt. “There are some benefits of this type of financing including certainty of funding and financial flexibility. I’d have absolutely no hesitation tapping the market again and in fact I’ve been suggesting it to a number of other executives at other companies.”
Investors deposited a record $5 billion into U.S. funds that purchase floating-rate debt last month, adding to the $4.4 billion of inflows in January, according to Bank of America Corp. The average yield on leveraged loans has dropped 25 basis points since Dec. 31 to 5.90 percent, the least in records going back to 2007, JPMorgan Chase & Co. data show. A basis point is 0.01 percentage point.
U.S. leveraged term loan volumes rose 25 percent to a record $465 billion last year from $373 billion in 2011, almost double 2010’s $233 billion, data compiled by UBS show. Already $121 billion of facilities have been signed since Dec. 31. The loans are a form of high-risk debt that carry ratings of less than Baa3 by Moody’s Investors Service and below BBB- by Standard & Poor’s.
Syndicated loan volumes in the Asia-Pacific region outside Japan slumped 18 percent last year to $377.9 billion, according to data compiled by Bloomberg. Facilities signed since Dec. 31 total $30 billion, the slowest start to a year in seven.
Atlas Iron Ltd. (AGO), which has mines in Western Australia, completed a $325 million so-called Term B financing in December. The debt will help the company meet its Pilbara iron ore production target of 12 million tonnes a year by the end of 2013, according to a Dec. 10 stock exchange statement.
Leveraged loans may also have features that investors call “covenant-lite,” meaning they contain less protection for investors than typical loans in exchange for a higher rate.
The loans feature what are called incurrence-based financial covenants. That means lenders only have the right to test whether borrowers have violated the terms of the loans when they seek to raise additional debt or pay dividends. By contrast, typical bank debt maintenance covenants are tested either quarterly or semi-annually and if breached, can trigger a default, giving banks the right to accelerate repayment.
“Most Australian companies have historically been financed primarily by Australian bank debt,” said Paul Allan, the head of Credit Suisse’s Sydney-based U.S. financing team. “This diversifies their funding sources and while the cost may often be a little higher than the bank debt available in the domestic Australian market, the benefits of the greater flexibility generally outweigh the higher cost.”
Credit Suisse helped organize one of Australia’s first Term B loans in 2003 when Burns Philp & Co., a food company which once owned cereal maker Uncle Toby’s, borrowed about $340 million as part of its A$2.4 billion ($2.5 billion) financing to acquire Goodman Fielder Ltd. (GFF), then Australia’s largest baker. In 2006, Credit Suisse helped raise $1.1 billion, including a $790 million Term B loan, for Boart Longyear Ltd. (BLY), a provider of mineral exploration drilling services.
“There will be deals that get done in the U.S. and to the extent that happens it’s disappointing,” said Gavin Chappell, the head of loans and syndications at Westpac Banking Corp. (WBC) “It would be nice if there were enough liquidity for some of those deals to be done by institutions in Asia but in Australia at least, the market isn’t fully developed.”
Asset managers need to be able to easily trade their investments and have a range of loans to choose from, which isn’t yet the case in smaller markets, Chappell said.
Incurrence-based covenants are popular with borrowers whose revenues, and earnings, may be volatile. When iron ore prices plunged mid-last year and concerns were raised about Fortescue’s covenant compliance, the Perth-based company responded by refinancing its entire bank debt exposure in the U.S. high-yield loan market with incurrence-based covenants only, according to Brad Robinson, a partner at Corrs Chambers Westgarth.
“The Fortescue experience has put the benefits of incurrence covenants firmly on the radar of Australian resources sector executives,” Melbourne-based Robinson said.
Atlas Iron’s financing comprises a $275 million, five-year term loan and an undrawn A$50 million three-year revolver, both of which contain no covenants tied to how much in earnings it needs to generate to keep from violating the terms of the financing.
“Compared with bank loans, Term B loans can be issued on a covenant-lite basis with longer tenors, bigger volumes and virtually no amortization,” said Kevin Bush, the Sydney-based head of leveraged and acquisition finance at UBS, the lead underwriter of Nine Entertainment’s facility.
An amortizing loan is one where the principal is paid down over the life of the loan, rather than in a lump sum at the final maturity date.
Because Term B funds come from U.S. institutional investors, which only have U.S. dollars to invest, loans typically aren’t made in any other currency. Companies that don’t have a natural hedge of U.S. dollar revenues have to swap the borrowings back into a local currency, incurring cross currency swap expenses.
“This cross currency hurdle has proved too high for some borrowers,” Robinson said. “One exception was Nine, which has shown for the right credit, in the right circumstances, the economics of a Term Loan B may stack up notwithstanding the absence of U.S. dollar revenues. It will be interesting to see if other similarly situated companies can also get the economics to work.”
Nine Entertainment, which is controlled by private equity firm CVC Asia Pacific Ltd. and counts among its assets television station Nine Network Australia and Ticketek, is paying interest at 2.75 percentage points more than the London interbank offered rate for the seven-year facility. The minimum Libor rate, or floor, used in calculating the interest is 0.75 percent.
The margin shrinks to 2.5 percentage points if Nine Entertainment is able to reduce net leverage to 2.5 times.
Demand was so strong that Nine Entertainment was able to reduce incentives offered to investors twice. It originally offered a discount of 99 cents on the dollar, then 99.75 cents and finally 99.875 cents, and still received about $2 billion of offers, Kelly said. Decreasing the discount at which a loan is sold increases proceeds for the company and reduces the yield to investors.
The Sydney-based media company also received a A$100 million working capital facility. Until that facility is drawn, or utilized, Nine must pay a fee of about 50 basis points on the debt, a fraction of the cost for undrawn working capital facilities in Australia, according to Kelly.
Including swap and hedging costs, Nine is paying an all-in rate for its $735 million loan of 7.25 percent. “But when you factor in what we’re getting, and consider what the cost of refinancing would be every three to four years in the Australian bank debt market, it’s very comparable,” Kelly said.
Deutsche Bank AG, Morgan Stanley and Nomura Holdings Inc. underwrote the facility alongside UBS.
Speculative-grade dollar bonds sold by companies in Asia are yielding 6.192 percent, versus 7.565 percent a year ago, HSBC Holdings Plc indexes show. Dollar loans signed in the Asia- Pacific region outside Japan since June 30 pay an average interest margin over Libor of 254.3 basis points, according to data compiled by Bloomberg.
Atlas Iron is paying a margin of 7.5 percent with a Libor floor of 1.25 percent for its $275 million loan. Credit Suisse was the loan’s sole lead arranger and underwriter, while Goldman Sachs Group Inc. (GS) acted as co-manager.
“This is a great market and companies should be using it,” said Anton Rohner, the chief financial officer of Atlas Iron. “We’re a company that needs cash to develop. We wanted a facility which was covenant-lite so if we do have a negative cash position one month, it doesn’t trigger a situation where the debt can be called.”
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