A Change of Season

Don't let a turn in the credit cycle catch you napping.

Darren Wells knows a good deal when he sees one. The senior vice president for business development and treasurer of $19.7 billion Goodyear Tire & Rubber Co. seized on favorable credit-market conditions in 2003 to restructure approximately $3.3 billion of credit facilities. Wells swung into action again in 2004 when he refinanced much of that debt on even better terms, then again in 2005 when still better terms could be had. Ultimately, the tire maker wound up with five- and six-year facilities on terms a Single-B-Plus credit could only have dreamed of a few years earlier.

Given some signs that the good times were coming to an end, Wells was understandably a little surprised when bankers began showing up at his door again in early 2006, encouraging him to refinance for the fourth time in four years. “I saw what might have been the most aggressive credit market we had seen,” he recalls. The company was receiving regular offers to refinance all that debt yet again at lower interest rates and with fewer financial covenants. Interest-rate spreads over Libor were compressed to levels Goodyear had never seen before. “These things,” says Wells, “were indications of the loosest credit requirements you could hope for.”

But good times do come to an end. While bank credit remains readily available today, Wells noticed that by the middle of this year, many of those bankers had stopped showing up. With more evidence of an economic slowdown and more concern about inflation, Goodyear was no longer the recipient of generous offers. “People weren’t coming to me and saying, ‘Here it is, but it’s much worse,’” he says. “They just stopped coming, which means they probably couldn’t provide enough benefit to make it sound worthwhile.”

A Turning Point?

Wells has seen other signs that the tone of the credit market may be changing. Part of his job involves estimating the prices various Goodyear businesses might command on the auction block. As part of that, he analyzes how much leverage potential buyers might be granted. “What we have heard,” says Wells, “is that there may be a marginal reduction in the amount of leverage that financial buyers can get to purchase businesses.” He estimates that the amount of financing banks are willing to provide in terms of multiples of EBITDA has fallen from earlier levels by roughly 0.25 times. That’s not a dramatic change, but it may indicate that the credit cycle has reached a turning point.

There are other hints, as well. Fitch Ratings currently has about 15 percent of the industrial companies it rates on negative outlook, up from 11 percent a year ago. And Meredith Coffey, director of analysis for Reuters Loan Pricing Corp., notes that the supply of high-yield loans being brought to market by corporate borrowers has jumped dramatically in the past year, threatening the tenuous balance between loan supply and investor demand. Most of those loans are sold to institutional investors, such as hedge funds. Last year at this time there was about $19 billion of such loans in the pipeline, Coffey says. This year, there is about $57 billion. Because of the shift in the supply-demand equation, she says, her firm has observed spreads increasing on these leveraged institutional loans, which tend to presage spreads on bank-only leveraged loans. In addition, she says, “we’ve also seen pushback on doing deals without covenants, so deals will be more heavily covenanted going forward. And there’s no more squishiness around what defines EBITDA, where projections are going, things like that.”

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