The market is capable of scaling the Wall of Debt, says Clive Wells
The market has been talking – and worrying – about the ’Wall of Debt’ for a while now. At times the talk has been in the same slightly hushed, concerned tones that accompanied discussions around the Y2K issue that was supposed to threaten the entire banking industry, if not civilisation itself. The message was that, given the amount of debt that was due for repayment in the period 2013-15, there would not be sufficient liquidity in the debt markets to ensure that all that debt was refinanced – so borrowers ought to do something about it quickly.
One estimate is that between 2011 and 2016 there is $814bn (£503bn) of leveraged buyout (LBO) debt globally that needs refinancing, with a peak requirement in 2014 of a little under $200bn. The regions where this was thought to be the biggest issue are North America and Europe – that is, where most of the LBOs occurred that put the debt in place.
The issue affected LBOs in various sectors – retail, telecoms, healthcare, real estate – although the impact (and timing) differs in different sectors. Some are in better shape than others in light of the macroeconomic situation.
Bankers were able to produce slides that illustrated the issue with startling clarity. The sheer size of the numbers was impressive – and worrying. However, one banker admitted recently that now they use such slides just to frighten clients into hearing the rest of the presentation as to why the company needs to refinance and pay some fees to the bank. The reality the market is now facing is not as daunting.
If you go back a few months it is not hard to see why the market was worried. The numbers made pretty startling reading. There was a huge volume of debt to refinance, particularly highly leveraged debt that funded the private equity boom of the first half of the noughties.
When you compared those numbers with the anticipated liquidity in the bank debt market, it seemed clear that a good number of creditors would find themselves unable to refinance at maturity, regardless almost of how their business was performing, simply due to the lack of lenders available to refinance all those deals.
Clearly, the picture looked worse for some than others. The property sector is one with its own myriad problems, and other areas such as retail looked like a difficult refinancing mandate. However, it was generally thought that no borrower could afford to ignore the issue.
To some extent there was a double whammy. There were far more loans falling due than had been the case previously and also a shrinking pool of loan investors, as some non-bank participants withdrew from the lending market. Various collateralised loan obligations were at, or close to, the end of their reinvestment periods.
Suddenly the institutional tranche for the big-ticket LBOs looked like something that arrangers might not be able to sell to the market, and thus provide to borrowers. Also, certain banks were no longer in the market to lend, or at least not to the previous extent.
However, this is no longer something to worry about. This is because of bonds, both high-yield and, in particular, senior secured bonds. The high-yield market spotted the gap and leapt into it. High-yield issuance in Europe was at record levels in 2010 and the trend continues this year.
By ranking the bonds pari passu with other senior debt and giving them (proper) security, the bonds gained a wider appeal with investors. High-yield bonds were no longer the risky, effectively unsecured and structurally subordinated debt for only the brave but yield-hungry investor, and demand for such bonds remains strong. Loan investors being repaid in the period will generally want to reinvest the cash. Bonds are where a lot of that cash seems likely to head.
There are other reasons too: many prudent sponsors and companies did take the opportunity to refinance early to grab what bank liquidity was available, even if it meant increasing their funding costs earlier and a tightening of the terms. Others, largely outside the leveraged space, arranged forward start facilities. Meanwhile, others simply agreed to amend and extend their existing facilities, pushing out their refinancing requirement, perhaps beyond the peak period of borrower demand – again at the cost of increased pricing now in return for certainty.
Clearly, my optimism does not extend to all borrowers. There will of course always be deals that struggle to refinance – perhaps because high-yield is not suitable, or because their financial positions and performances mean they are always going to be last in the queue for new facilities. Some borrowers will only find the solution to their refinancing requirements not in a consensual refinancing, but in a rather more painful restructuring process.
Nor does it necessarily survive in all scenarios. Borrowers should also be careful not to be complacent and assume the issue has gone away for good. It is of course possible that the situation could deteriorate again. The high-yield market has been known to close at times and it is hardly the case that the bank market is back and firing on all cylinders just yet. The availability of financing does depend on the global economy at least continuing as it is.
The debt markets could also get spooked again and liquidity could dry up, although it is hard to imagine that governments would allow another Lehman to occur.
Clive Wells is a partner at Skadden Arps Slate Meagher & Flom