To Lend and Lend Not

Corporate borrowers are finding that an investment-grade credit rating makes a big difference.

Mother Necessity

There are some encouraging signs, however. Necessity, it appears, is the mother of invention in the loan market. Tesoro Petroleum Corp. was one of several deals in the works before September 11 that was subsequently postponed. The San Antonio­based oil refining and marketing company was in the market for an approximately $450 million term loan to help finance its acquisition of two oil refineries and other assets from British Petroleum. The stumbling block for the deal was the piece for institutional investors.

The issue, of course, was price. Libor, which most of the business sector’s variable debt is pegged to, hit 2.2 percent on October 31–more than 4.5 percent below its level of just a year earlier. At a yield of Libor plus 275 basis points, the terms were not particularly attractive to institutional investors strictly pursuing yield. The solution? Establish a floor for Libor. The new term loan established a floor of 3 percent, making the minimum yield 5.75 percent even if short-term rates continue to fall.

Coffey says the Tesoro deal is the first to use such a tactic to attract institutional investors. And it illustrates how the new syndicated loan market is behaving much more like the bond market, using pricing innovations to get deals done. One tactic, so-called price flexing, which allows borrowers and their syndicate arrangers to change the pricing of a deal based on investor demand, was pioneered by Chase Manhattan Bank in the 1990s. So, for example, a loan yielding Libor plus 250 basis points can be “flexed up” to Libor plus 300 points to clear the market.

Fans of Flexibility

Another option is to employ discounts on the loans. Earlier this year, Edison Mission Energy and American Greetings, among others, employed original- issue discounts on their loan packages in order to bring institutions into the deal. Like a bond, a term loan can be issued at a price of, say, $97, and return principal of $100 at maturity. Not exactly rocket science, but a new innovation for the lending market. It enhances the yield for institutional investors and, though proceeds on the deal are less for borrowers, the absolute interest expense remains the same. “There’s been a lot of innovation to deal with the dislocation in the market,” says Coffey. “And the more the loan market innovates, the more capital will be available to the asset class.”

One fan of the new, more-flexible loan market is Dale Parker, CFO of paper-products manufacturer Appleton Papers. “It certainly helped us get our deal done,” he says. Last December, when Appleton’s U.K.-based owner, AWA, indicated it wanted to sell the business, Parker and senior managers at the company decided they were interested in buying it. So, it turns out, were 2,500 other Appleton employees, who committed $107 million from their 401(k)s to execute a buyout. By early July, Parker had agreed on a sale price with AWA, and he was well on his way to arranging the financing. “We had a meeting set up with the bankers in the Sears Tower on September 13,” he says. The meeting was canceled and the deal postponed.

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