The end of cheap debt has arrived

I think I’ve made this point countless times by now, but here are just a few facts that demonstrate that the days of cov-lite cheap debt are long, long gone:

– Traders will tell you that the spreads on a generic Canadian Chartered Bank sub debt note have backed up from, say, 40 basis points over the underlying government bond rate to 60 basis points between March and July. In other words, investors perceive the risk associated with this tranche of paper has required a 50% increase in the risk premium if they are to own this part of the bank’s capital structure; over a 16 weeks period. “Incredible” is how one capital markets pro described it.

If a bank’s own paper is perceived to be more risky, what message does that send to the risk management group as they size up their institutions’ exposure to manufacturing co. loans in a 95 cent dollar era, for example?

– According to today’s WSJ, Cerberus is having trouble arranging the debt it needs to close on the Chrysler takeover:

“Chrysler’s auto business could have to pay interest of at least 9% on $10 billion of loans and more than 12% on a $2 billion slice. That’s around half a percentage point more than first planned. Bankers are also working tougher performance requirements, known as covenants, into the deal and plan to sell the debt at a discount to its face value.”

– The WSJ article also details the pain that KKR is having, as the debt supporting their latest big deal will now cost at least 0.5% more than planned:

KKR’s £11 billion purchase of Alliance Boots is Europe’s largest leveraged buyout to date, and the financing is being closely watched as a barometer of the global credit markets.

Late yesterday, the banks were working to identify new terms of the financing to win over investors. If those terms don’t work, the banks would have to decide whether to change the conditions of the loans further — or pull the offering for several months, people familiar with the situation said.

Their £11 billion takeover would be financed by six loans or credit facilities.

The largest loan is an eight-year £5.05 billion term loan. About two weeks ago, the banks met with investors and pitched that loan at a price that yields 2.75 percentage points above the London interbank offered rate, or Libor. Investors had to commit by today, people familiar with the matter said.

But, in recent days, when the banks returned to their top 15 or so potential investors, they found reluctant takers and began asking whether there would be appeal in the loan if it would be priced to yield at three percentage points or even 3.25 percentage points above Libor.

Additionally, it could be sold at a discount of 1% to 2% of face value, these people said. As of late yesterday, the banks were waiting to see whether those terms grabbed potential investors.

Here at home, we are still seeing some institutions, such as the incorrigible BDC, drop their pants on price and terms (even if they are incredibly slow to ultimately issue the term sheet), but the rest of the Canadian lending community will undoubtedly get the memo from on-high soon enough: do a better job pricing for risk if you want to keep your job. If KKR needs to pay 0.5% more in interest this summer to close their deals – with tighter covenants – why are we giving our loans away?

(BTW, as we never dropped our pricing or waived the idea of covenants to win business during the recent debt industry mayhem, we don’t now need to raise the pricing of our fixed rate loans to make up for past mistakes. We’ve closed 10 deals in 10 months and have several term sheets executed at the present time; I’m pleased to say that our prospective customers will see no change to our fixed rates this summer, even if KKR is watching their interest rates rise.)

MRM