Over US$4 trillion of corporate debt1 matures in the next four years – a legacy of the increasing refinancing requirements of the boom years, leveraged loans in the US and Europe and the short-term funding arrangements made during the global financial crisis. The scale of the refinancing requirement would be challenging at the best of times, but current economic circumstances suggest there are some very difficult negotiations ahead. The options for some companies could be very limited.
Uncertain and Uneven Growth
The round of refinancing that lies ahead is set to take place against a backdrop of continuing economic uncertainty. For one thing, the global recovery has generally been stuttering and uneven. In most advanced economies, the robust growth normally witnessed after a deep downturn is proving elusive. Meanwhile, a return to rapid economic expansion in the emerging markets of Latin America and the Asia-Pacific region has triggered unwelcome inflationary pressures.
Rising commodity prices feeding through to higher inflation rates have added to the problems of policy makers at a time when many governments are battling to reduce borrowing and retain the confidence of the markets. Question marks over sovereign creditworthiness – particularly in the eurozone – hang over a number of countries and the success or failure of governments to address the problem will have a major impact on the ability and willingness of banks and other institutions to refinance corporate debt.
Pressure on Banks
And of course, the banks have their own housekeeping to attend to, with many continuing to repair their balance sheets while also facing tighter capital adequacy rules under Basel III and increased regulation within national regulators’ jurisdictions.
This will also affect availability and cost of financing to borrowers, as will the shrinkage of the collateralised loan obligation (CLO) market, which was a significant factor in driving the volume of leveraged loans, accounting for up to 60% of current holdings of leveraged buy out (LBO) debt. This has reduced dramatically and with many CLO reinvestment periods expiring in the next few years, funding from this quarter will have to be refinanced from elsewhere.
Consequently, many companies will need to look beyond bank lending to manage upcoming maturities. The good news is that the high-yield bond market has grown, with record levels of issuances in 2010 (over US$300bn). Investors in this market are looking for yield and therefore have an appetite for speculative grade debt. However, the market is susceptible to shocks and can close down quite quickly when faced with an event, such as the Greek debt crisis, and its ability to absorb potential funding gaps left by the banks is at best uncertain.
We’re looking at a refinancing wall that will present challenges to a great many companies. Some will have to explore alternative sources of funding and there is certainly a need for proactive deleveraging and renewed focus on working capital management. That’s particularly true in the Europe, Middle East and Africa (EMEA) countries and North America, but the Asia-Pacific countries also face their own challenges.
Global and Regional Perspectives
Over US$4 trillion of corporate debt matures in the next four years. This refinancing wall may well present substantial challenges to a many companies. A percentage will have to explore alternative sources of funding and there is certainly a need for proactive deleveraging and renewed focus on working capital management.
- There is an increasing level of speculative-grade and LBO debt maturing over the next four years.
- Banks face pressures from Basel III, national regulators and eurozone financial instability impacting lending conditions and cost of borrowing.
Figure 2: EMEA Corporate Investment-grade, Speculative-grade Debt and Unrated LBO Debt Maturities (US$bn)
In the EMEA region there is currently over US$1.3 trillion of corporate debt due to mature over the next four years, and within that overall figure is a material level of maturing lower rated speculative-grade debt and unrated LBO debt. Around US$470bn of the debt coming to maturity is speculative-grade and unrated LBO debt, much of which is related to deals carried out during the years of the credit boom.
The challenges are clear. Overall lending conditions remain tight, as banks continue to repair balance sheets and face up to additional constraints imposed by Basel III and national regulators. Added to that, is the fact that in Europe – as in the US – LBO refinancing will be impacted by reduced levels of activity in the CLO market which, according to Standard & Poor’s, only had issuance of US$1.4bn in 2010 (compared to US$38.6bn at the height of the market in 2006) and constraints in CLO reinvestment periods.
Against this backdrop, there has been a shift in focus towards the bond markets with the European high yield bond market having a record level of issuance of over US$65bn in 2010 (compared to US$43bn in 2009), according to Thomson Reuters. However, the high yield bond market is susceptible to shocks such as seen during the Greek debt crisis in 2010.
There remains significant financial instability in the eurozone as evidenced by uncertainty over the future of Portugal’s debt reduction measures following the resignation of the prime minister (and subsequent request for EU and IMF funding) and the revelation that Irish banks needed a further €24bn capital injection. The continuing political and economic turmoil underlines concerns over sovereign creditworthiness in the eurozone and the links to the banking system, which is leading to pressures in the funding markets. Despite this, the European Central Bank’s (ECB) decision in April 2011 to raise interest rates for the first time in three years will add further pressure to cost of borrowing.
Political unrest in the Middle East and north Africa MENA has provided further uncertainty both locally and globally. Tensions in this region will, inter alia, put pressure on the oil price affecting economies across the world.
- Increasing level of speculative-grade and LBO debt maturing in the US over the next four years.
- Low interest rate environment and quantitative easing (QE) have aided the lending environment. However, the banking system faces challenges from new international and domestic regulation and high levels of real estate loans.
Figure 4: US Corporate Invesment-grade and Speculative-grade Debt Maturities by Year (US$bn)
There is over US$1.7 trillion of corporate debt maturing in the US over the next five years with US$946bn being speculative grade reflecting the maturities of leveraged loans written in the boom years. There is an increasing level of maturing lower-rated speculative grade debt with over US$700bn of the debt maturing in the next five years rated B or below by S&P.
The lending environment in the US has been helped by QE and a low interest rate environment. However, the banking system still faces significant challenges. On the regulatory front, lending by US banks will be affected not only by the internationally applied constraints of Basel III but also by the domestic Dodd-Frank legislation, designed to tighten regulation in the financial sector. Meanwhile, high levels of real estate loans are still a significant concern for the banking industry.
Recent activity suggests the bond market will provide a source of refinancing over the next four years. There was a record level of high-yield bonds issued in 2010 – coming in at over US$200bn, compared to US$138bn in 2009 according to Moody’s. However, the market, despite being more established than in Europe, is still vulnerable to shocks, even to those occurring in Europe (as seen during the Greek debt crisis).
As in Europe, there is a relative lack of appetite for securitization and marked decline in CLO activity (with CLO issuance of only US$5bn in 2010 compared to US$107bn at the height of the market in 2006, according to JP Morgan). That fact, combined with CLO reinvestment periods starting to expire, will cause some challenges for leveraged loan refinancing. New CLO issuance is occurring but at modest levels and regulatory changes may restrict this further.
Another important factor to consider is that capital inflows into the growing Latin American economies (aided by the low interest rates in advanced economies and investors looking to profit from the differentials in interest rates with emerging markets) have driven an increase in corporate debt levels as a percentage of gross domestic product (GDP). This over time may lead to the lowering of the average credit quality of assets and there is also a risk of reversal in the capital inflows.
- The banking system in Asia-Pacific came out of the financial crisis in relatively good shape and liquidity has returned to the financial system.
- Refinancing requirements should be manageable. However, there is uncertainty from inflationary pressures, monetary policy being used to cool economies, regulatory authorities targeting banks and the recent natural disaster in Japan.
Figure 6: Asia-Pacific Corporate Bank Facility and Bond Maturities Q2 2011 – 2015 (US$bn)
Asian banks generally came out of the financial crisis in considerably better shape than their western counterparts, benefitting from the high saving ratio in the region. However, that’s not to say that the Asia-Pacific region is immune from the problems of Europe and North America. Asian banks do use funding from western counterparts which can cause some risk in the event of renewed concerns in the wider financial system. Likewise, corporates in Korea, Australia and India have sizeable foreign refinancing needs.
Liquidity has returned to the financial system with 2010 having the highest ever level of loans and bonds issued on record, partly driven by the increasing levels of international funds flowing into the region. However, along with it is an increase in the level of private sector debt to GDP ratios (particularly in China, India and Korea where levels are approaching historic highs) which present its own risks.
There may well be capacity to absorb the upcoming refinancing requirements, much of which is from short-term funding arranged during the financial crisis. However, there are potential dark clouds on the horizon. Core inflation is on the rise and a continued appreciation in currencies is having a clear impact on exports. Meanwhile, monetary policy is being aggressively used to cool economies (and, in particular, hot sectors such as real estate) and regulatory authorities – with China leading the way – are beginning to target the banks by raising reserve requirements. This may present new constraints.
The region has also been rocked by a series of natural disasters, such as the earthquake and tsunami affecting Japan. This created further economic uncertainty, with the Bank of Japan (BoJ) feeling the need to inject US$285bn into the financial market. The full economic implications have yet to be felt but there will clearly be challenges for companies with manufacturing plants shut down by the disasters with knock-on effects on the global supply chain, and those in the nuclear industry (all over the world). The ramifications for overseas lending by Japanese financial institutions is also at best
In summary, at just the time when there will be an increased demand for refinancing in the years ahead, there may well be constraints on the capacity of some financial institutions to satisfy that demand. Some borrowers, and in particular non-investment-grade borrowers, may find the circumstances especially challenging and need to explore alternative sources of finance and deploy effective operational strategies to negotiate successfully the ‘debt refinancing wall’.
The circumstances facing the regions of the world are different, but there are clearly some common factors, namely:
- Pressures on availability, and cost, of funding.
- Increasing financial requirements – whether for growth, sovereigns or refinancing.
Companies with maturing loans will have a range of options and many will be looking to (or have to) refinance their debt through the bank or bond market. However, if the debt can be financed in this way, it may well be at a higher cost.
Arguably, the biggest concern is over the increasingly lower rated speculative-grade, LBO debt and commercial real estate debt maturing over the next five years. Companies seeking to refinance this kind of debt will be more susceptible to macroeconomic and industry trends providing significant challenges.
The bond markets, particularly the high-yield bond market, have been buoyant but are sensitive to macroeconomic changes and shocks and cannot be relied upon to meet the entire shortfall in refinancing requirements on their own. This market is also less suitable or inaccessible to smaller and medium-sized companies.
As well as traditional bank and bond refinancing we will not doubt continue to see a variety of other solutions to manage upcoming maturities, including: other sources of financing (such as private placements, asset based lending and convertible bonds), merger and acquisition (M&A) activity, initial public offerings (IPOs), non-core disposals and companies deleveraging through cash generation.
Private equity firms may also be a source of funds. At present, private equity (PE) funds reportedly have access to US$400bn, which could be used in M&A, equity injections and debt buy-backs to maintain control of existing investments. However, we will undoubtedly increasingly also see situations where debt restructuring will be required to provide a sustainable capital structure.
The appetite of lenders to participate in ‘amend and extend’ (where lenders extend the maturity of leveraged loans in return for better economic returns) will be dependent on the macroeconomic environment and lenders may prefer to see an alternative solution and debt restructuring.
The range of available options to smaller and medium-sized companies will be more limited and they could face greater challenges with their upcoming maturities than larger companies.
During this period of uncertainty, companies should consider their refinancing requirements and options as early as possible. Meanwhile, it’s important to remember that businesses can put themselves into a stronger position ahead of refinancing and/or restructuring through a range of measures, including:
- Improving working capital and free cash flow.
- Implementing cost rationalisation.
- Formulating a clear strategy, underpinned by a clearly articulated business plan.
In addition, businesses facing situations of increasing distress will require effective contingency planning to help preserve value in cases where a consensual restructuring may not be achieved.
The next four years will see pressure on the ability of banks and the capital markets to cope with demand for finance. Companies that will be refinancing during this period should begin preparations now.
1References to corporate debt, throughout the document, refer to debt owed by corporates which are classified as being outside the financial sector. Data for US and EMEA corporate debt refers to rated non-financial corporate debt (from S&P and Moody’s respectively). Data for Canada, Latin America and Asia-Pacific is sourced from either the Thomson Reuters or Bloomberg databases.
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