Though banks have always used flex terms to mitigate risk in syndicated loans, volatile financial markets may be pushing them to add broader terms when arranging loans for leveraged buyouts.
"Banks, they're wary -- wary of being stuck with a failed syndication," says Mario Ippolito, a leveraged finance partner at Paul Hastings LLP. "The macroeconomic uncertainties are creating swings in the market."
That's not to say that there are necessarily more deals with flex terms written into them. As one banker says, banks should always have the basic protection of certain flex terms in good and bad markets. Also, a company's financial profile and industry has a big effect on whether a loan syndicates at "price talk," the initial spread over LIBOR, or flexes tighter (to be more attractive to borrowers) or wider (to please investors).
The fact that market conditions are more tumultuous this summer than they were in, say, January, February or March, is causing banks to more frequently seek looser flex terms. Indeed, 29% of leveraged-finance institutional loans flexed tighter in January, while none flexed wider, according to data provided by Macquarie Capital. In June, however, 17% flexed tighter, while 19% flexed wider, Macquarie says.
The average institutional spread over LIBOR was 500 basis points in January, and 515 basis points in June.
Another source says banks build more room in flex deals during volatile markets because underwriting fees can be eaten up if a market swings too far at the wrong time.
Private equity sponsors recognize that volatility will affect flex, Ippolito says. While the market stabilized after the European sovereign debt crisis last summer, and made pricing appealing for sponsors in late 2011 and early 2012, they're now facing a different reality as borrowers. Instead of a market that features investors scrapping for yield, borrowers are conceding to commitment letters that flex and result in sweetened terms for investors.
For example, consider a $260 million term loan that Ippolito worked on for KPS Capital Partners LP's acquisition of Waupaca Foundry Inc. The loan cleared up 175 basis points from price talk to LIBOR plus 725 basis points. It gained a 5% amortization and a 102 soft-call premium instead of its original 101 soft call, while the original issue discount rose 50 basis points to 98. "It was flexed pretty substantially," Ippolito says.
Ippolito cautioned that deals have cleared without flex provisions being enacted, adding that some of Waupaca's revenue is dependent on the automotive industry, which can be volatile. Sold by German-based ThyssenKrupp AG in May to KPS, Waupaca is the world's largest iron foundry and primarily serves the automotive, commercial vehicle, agriculture and construction industries.
Other leveraged deals have priced higher than the price talk, too. A $220 million term loan for Genstar Capital's purchase of eResearch Technology Inc. priced at the end of June at LIBOR plus 650 basis points, 50 points higher than talk. A couple of weeks earlier, a $175 million first-lien term loan for Gores Group LLC's buyout of ELO Touch Solutions Inc. priced at LIBOR plus 650 basis points, 125 basis points more than price talk. It had an original issue discount of 96, instead of talk at 98.
Others, as noted by Macquarie, have still flexed tighter or priced at talk, especially companies in healthcare.
Stephen Mehos, senior managing director at Macquarie and head of its leveraged finance business, says nearly every deal has a rate-based flex, and often a structure-based flex. Rate-based terms might include a hike of 150 to 250 basis points, depending on the credit ratings of the LBO target, whereas a structure-based flex may shift bank paper between various tranches of the loan, such as turning some from senior into subordinated debt, depending on the leverage.
Mehos notes that more deals have flexed wider than earlier in the year, although they remain a minority. There aren't many large deals out there, but the market is open and money is flowing, both Ippolito and Mehos say. "The preponderance of our deals have flexed tighter or maintained initial pricing. Frankly, some of that is timing," says Mehos. "The market in general is open. Investors are more receptive to certain sectors. If anything, what we've seen is a little more bifurcation by sector." n
David Holley reports on leveraged finance for The Deal magazine.