From the December-January 2010 issue of Treasury & Risk magazine

Debt Strategy Dilemma

Treasurers are peering farther into the future when it comes to credit. Take for example this unidentified treasurer's question to a banking panel at the recent Association for Financial Professionals annual meeting in San Francisco, as reported by Bruce Lynn, managing partner of the Financial Executives Consulting Group. The question: "I have a $1 billion revolver coming due in 2013. My pricing today is Libor plus 75 basis points. My banks will extend my loan at Libor plus 300. What should I do?" The bankers' answers: Make sure the $1 billion is still needed and cut back, if possible; go to the bond market for longer term money; and expect to pay more when you do renew, says Lynn.

While a 2013 maturity date seems a comfortable timeline, treasurers are wondering what to do about credit facilities that still have a year or two or even three to run. Normally, you don't renegotiate to add two or three percentage points to your spread and double or triple your fees, but these are not normal times. Over the next three years, massive amounts of bank credit will run out.

"There is $600 billion of corporate debt maturing in 2010, $700 billion in 2011 and almost $1 trillion in 2012. That's well over $2 trillion," notes Jim Simpson, a Stamford, Conn.-based consultant and co-founder of Debt Compliance Services. "So there is concern about crowding out in the market, particularly with fewer bank lenders and tighter credit standards." (See graph on Page 38.) That calendar poses a dilemma, Simpson explains: Do treasurers wait until a few months before their loan agreement is due to expire, enjoying the good rates they locked in during happier times but taking a chance that they might get shut out? Or do they try to beat the crowd and renegotiate a deal that will take them past the bubble, knowing it will mean paying more and agreeing to more onerous conditions than their current deal?

Such concerns are speeding up refinancing activity. "We have one client with a revolver that matures in 2011, and they're already thinking about how they want to handle it," reports Stephen Kantor, senior consultant at Treasury Strategies in Chicago. A big issue is finding out what non-credit business will be expected by credit banks, he says. "Treasury staffs have to think about how to align a lot of moving parts."

"We're seeing some of the higher-rated companies do 'amend-and-extend' deals, going to their banks and saying, 'We want to move maturities out to 2014 or 2015. Let's negotiate rates and spreads,'" Simpson says. Many banks welcome opportunities to earn higher rates and impose tighter restrictions. "We're seeing banks and corporate borrowers reach a middle ground where borrowers agree to pay more and banks agree to charge less than the current market rates they would offer to a new borrower or a borrower forced to renegotiate an expiring facility," Simpson reports.

San Francisco-based Bechtel, with $31 billion in 2008 revenue, has several backup credit facilities and started layering in its renewals last spring, when the market was near its worst, reports Kevin Leader, Bechtel's treasurer and principal vice president. "At that time, many treasurers were waiting for things to improve. We, too, expected brighter days, but also felt that things might get worse before getting better," he says. "So we tested the waters with one of our smaller facilities and bank groups in preparation for renewing other facilities in 2010 and 2011."

The result was a slightly smaller multiyear facility at a substantially higher price than the old one, Leader reports. "We had to pay a multiple of what we had been paying, which was not a surprise. Expectations of ancillary business were not something that was going to reduce pricing. This credit was priced so that a bank could meet its return on risk-adjusted capital targets on the credit alone. Even if you passed the relationship profitability and the credit quality litmus tests, you were dealing with the capital committees at the banks. Relationship managers and credit committees were very supportive but clearly did not have the final say on approval."

Shrinking the facility was Bechtel's concession to banks in the group left with a "credit overhang" due to mergers, Leader explains. "Relationships count more than ever now, and negotiating well means understanding the pressures that banks are under and accommodating them when you can," he says. "We accomplished a credit renewal in a very difficult market by treating our banks with respect, now and over time. At the end of the day, it was a win-win for us by getting an extended tenor and for the banks by improving the return on the asset and, where appropriate, reducing the commitment level."

Even with credit priced to stand on its own, Leader still feels obliged to give credit banks Bechtel's non-credit business. "While one can argue that pricing being where it is, the demands for ancillary business should be less pressing, rewarding banks that support you with their capital is still the core of successful relationships."

He expects that sometime in the coming year he will open at least one of the company's other facilities to extend the maturity, and he is hoping that five-year maturities make a comeback. "Last spring, most deals were for 364 days with three years on the outside," he says. "Getting anything more than a three-year deal done required a strong relationship angle. Now banks are more willing to talk about longer maturities."

Leader hopes to keep commitment levels where they are today but knows that certain banks will drop out altogether and others will likely look to reduce their level. "Other banks, because they are bigger due to mergers or because they are refining their lending focus, might actually want to increase their commitment to us, and we are seeing a fairly high level of calling from banks not currently in our deals," he says.

Winston-Salem, N.C.-based Hanesbrands, with $4.2 billion in 2008 revenue, has a $500 million revolver that matures in September 2011. "That's a little less than a year until we go current," says treasurer Rick Moss. "At this stage, we're evaluating alternatives, not actually negotiating. Most treasuries don't want to carry a revolver as a current liability. Investors don't like it, and it gives banks more power in the negotiations."

Debt with a maturity greater than one year is carried as long-term debt on financial statements, while a maturity of less than one year makes it a current liability. Public companies generally redo credit facilities before they go current, while private companies more often hold onto their pre-crunch deals as long as possible and start negotiations about six months before expiration, says John Mostofi, head of the western region for Bank of America Business Capital.

While a recovery seems to be under way, "it could take 18 to 24 months for banks to fully recover, and we can't wait that long," Moss says. The result is likely to be a smaller revolver, he concedes. "If we went back to the banks now, we'd probably get less. We're looking at how we can get by with a smaller revolver. We don't use it that often. If we have to shrink our revolver, we'll probably compensate by increasing our cash balances, but that is expensive because you don't get much of a return on balance-sheet cash these days."

Nevertheless, in this economy, smaller can be better, and many borrowers are downsizing credit agreements voluntarily at renewal, reports Ioana Barza, senior market analyst at Thomson Reuters Loan Pricing Corp. in New York City. "In the bull market, debt issuers were able to get a lot of credit committed at attractive rates. Now issuers are cost-conscious, rethinking how much they need and reducing their credits by 25% or more," she says. "It's harder to justify a large liquidity cushion when it costs so much more."

Simpson agrees, citing a client that has "a very large backup facility" and is negotiating an amend-and-extend agreement that will cut the facility by 40%. If a lot of treasuries trim excess backup, the refinancing bubble and overcrowding risk could be less severe, he points out.

Companies with backup facilities are probably issuing less commercial paper now because of a slower economy, so they don't need as large a backup, notes Jim Colby, assistant treasurer of $36 billion Honeywell in Morristown, N.J. "Banks will be pickier about the credits they participate in, so bank groups may be smaller," he adds.

While shrinking the size of a facility may be smart, there's risk in shrinking the size of a bank group because it increases counterparty exposure. A bank could get in serious financial trouble or decide to move away from your kind of business, Moss points out. "You want the credit, but you also want to be careful who you get in bed with."

Allentown, Pa.-based Air Products and Chemicals, with $10.4 billion of 2008 revenue, has a $1.45 billion backup credit facility with 15 banks that matures in May 2011. Assistant treasurer Greg Weigard is taking a wait-and-see approach, hoping that access and prices improve. "We think the markets are recovering, and we want to let them get even better," he says. "What concerns us most is the tenor. For a while, the best you could hope for was 364 days. Now three years is doable. We're hoping we can get five years by next year."

For now, Weigard is talking with the company's banks about credit availability and "most think that availability will continue to improve," he says. He intends to start negotiating in earnest in the first half of 2010, a little earlier than normal. "We know banks will choose which companies to offer scarce credit to and will favor companies that have treated them well and offer them attractive non-credit business."

There is less pressure on $6.7 billion Eastman Chemical of Kingsport, Tenn. Its treasury negotiated a five-year revolver in April 2006, then exercised its option to extend the facility by a year in April 2007 and added another year in April 2008, which pushed the maturity out to April 2013. "Our banks told us that we were one of the last companies to be granted an extension in the spring of 2008, when the credit contraction was under way," says assistant treasurer Michael Watts.

That gives Eastman time to wait for greater clarity. "Many banks are restructuring, selling assets and refocusing their strategies," Watts notes. "We expect further changes by the banks but are uncertain what they will be. We think that delaying a renewal will give us a clearer understanding of our banking partners' business profiles coming out of the crisis." Meanwhile, Eastman is ready to move if the market turns favorable.

Prices are already starting to soften as banks begin to compete for higher quality credits, Barza reports. And banks aren't seeing a lot of refinancing activity in the investment-grade space. "Many borrowers with five-year facilities put in place in happier times are sitting on those until the market improves," she says, pointing out that investment-grade syndicated credit deals are at their lowest level since 1996. That may change as more of the five-year facilities approach maturity, Barza notes.

The Libor floor that most banks required in the first half of 2009 has largely disappeared, reports B of A's Mostofi. He expects tenors to remain at three years for the foreseeable future.

"Our $2.8 billion facility doesn't mature until 2012," Honeywell's Colby reports, "and the longest term you can get today is three years, so we'd gain little from redoing our credit facility now. The market is improving, so we're better off waiting."

Waiting may pay off if the economy continues to recover, but it could be costly if the economy gets worse, and at least one survey suggests that finance executives are not optimistic. In its most recent quarterly survey of 150 financial officers, Adaptive Planning, the Mountain View, Calif.-based software provider, found growing pessimism. More finance pros predicted a later recovery or a W-shaped recession, with another significant dip ahead, reports CEO Bill Soward.

Crowding out is the real threat, not just because of maturing corporate debt but because governments have gone so deeply in debt to combat the recession, notes Paul LaRock, a principal at Treasury Strategies. "From the middle of 2010 through 2012, there will be heavy demand on the credit markets. Corporations will be trying to arrange debt in a stressed market." That will make it expensive. "Forget about rates," LaRock advises. "Think about the cost of not having access to credit."

If you're renegotiating a new credit deal in today's tight market, be careful about covenants, cautions Greg Schneider, Adaptive Planning's vice president of marketing. "We've seen a steep increase in companies that are redoing their business plans but still missing their numbers," he observes. "In the third quarter of 2009, 61% of companies updated plans but still came in under their revised revenue forecast." Leave enough room in covenants to miss your numbers by a little, he advises.

Debt strategies split, depending on whether or not treasurers expect to draw on a credit facility. Treasurers with drawn credit with longer-term maturities are deserting the bank market for the bond market, Barza says. "The tables have turned and bond offerings are where treasurers are getting money." This is particularly true for leveraged finance, thanks to a vibrant high-yield bond market. "Out of $100 billion in high-yield bond offerings in 2009, $54 billion has been used to pay down bank loans," she notes.

In the investment-grade market, backup facilities for commercial paper programs were usually for five years before the crash. Now, with most banks offering only 364-day facilities at significantly higher rates, issuers have been sitting on their longer-term commitments and waiting until they're closer to maturity to do anything, Barza says. "It makes no sense to trade a longer-term facility for a 364-day facility that carries higher fees," she observes. But some BBB issuers are offered three-year deals and snapping them up, she adds.

Generally lower-rated companies want the comfort of three-year commitments and are willing to pay for them, while higher-rated companies are satisfied, if they don't have longer-term facilities in force, to keep renewing at 364 days and save money until longer terms open up, Barza says. They'd like to redo their deals for five years. A credit commitment for less than a year requires less bank capital.

Spreads have gone up for both drawn and undrawn facilities. Drawn spreads, especially for higher-rated issuers, now are often tied to the credit default swap (CDS) rate or a CDS index, Barza reports. That means the spread reacts quickly to news or even rumors. Higher-rated companies are willing to take that risk, confident that they won't draw on the funds. Lower-rated companies are negotiating straight spreads.

No matter when treasurers renegotiate a credit agreement, it's probably good strategy to rely less on banks for credit. "If I were a treasurer, looking at the credits coming up for renewal in 2011 and 2012," Lynn says, "I would be emphasizing global cash visibility and going through the couch for quarters to increase my operating cash flow and reduce my need to borrow."

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