Outlook 2009: Higher coupons, OIDs, Libor floors and covenants expected to be important components

By Sara Rosenberg

New York, Dec. 31 - New credit facilities in the 2009 year are expected to need a certain type of structure in order to be able to successfully syndicate, and market sources are anticipating that this structure will include juicier coupons than what was seen in most of 2008, original issue discounts, Libor floors and a continued reliance on covenants.

On average, sources think that the actual spread over Libor that new bank deals will have when coming to market will be somewhere in the Libor plus 400 basis points to 600 bps context.

"Discounted spreads will decline, [meaning] prices will rise and coupons will be higher than index average. Lots of 400-600 coupons," a buyside source said.

"I think you'll see higher coupons, lower OIDs, versus what was done this year. You're going to see more issuers looking to pay higher coupons, effectively financing their discount. [Average spread over Libor], call it 550, 600," a sellside source remarked.

Middle market deals anticipated around 700

One sellside source told Prospect News that middle market deals, on the other hand, will probably come with pricing of Libor plus 700 bps, at least in the foreseeable future.

"A middle market deal getting done now is generally [Libor] plus 700 at 97 and I think that's where it's going to stay. There's a limit on how high pricing can go before it just stops a deal from happening. As people come back into the market, it will tend to come down a little bit, so I think that's kind of a high water market," the sellside source said.

"Or you can look at yields. In the middle market, they're now 10% to 12% between the Libor floor, the OID and the spread. I think they're going to stay there for a while and then as people come back in the market, they'll tend to come down a little bit- maybe the second half.

"Larger deals, I just don't think they can get done. If the market comes back into '09, like mid-year, then that kind of a yield is going to come down and I think it will be more like the 10% to 12% kind of range. If Libor is 2%, by historic standards, that's a pretty good yield. I think if the market kind of rights itself, that's where things are going to settle down, and then they'll come down from there," the sellside source added.

OIDs here to stay, for now

Original issue discounts are expected to remain part of the new deal structure in 2009, although some are guessing that the size of the discount will decrease compared to some 2008 deals based on the expectation that spreads will rise.

"Average [OID] will be around 93. I think when borrowers have a choice between coupon and OID, they prefer coupon. I think a lot of these are going to be best-efforts type deals and the market is going to dictate it a little bit. But if you're talking about the secondary market coming in to the 80s to get things done and the current coupons are in the mid-200s and you add 300 bps to that, you make up about 12 points of OID," one sellside source said.

"To say there will be none in the 80s is probably a little brazen, but I think most people will be targeting yields that have coupons, which keeps the OIDs in the 90s. You're going to have real covenants, you're going to have real amortization and if you're going to issue something at 80 and, in the first year, 5% is going back to paying lenders at par, that's pretty costly. [Discounts are] here to stay for the foreseeable future," the sellside source added.

Middle market deals also expected at a discount

One sellside source told Prospect News that middle market deals will also continue to be sold with an original issue discount in 2009, but he's expecting those transactions to come more in the high-90s.

"A standard starting OID is 97 and you see these extremes where if somebody's trying to raise a lot of money, they have to discount a lot more. That's not going to change. On a normal deal, I think they're, like, three to five points and I think they're going to stay there for a while. And as the market recovers they'll tend to narrow, but that's where they're going to be to start the year. People do expect OID as part of the yield component and right now the minimum they expect is 3%," the sellside source remarked.

"Earlier in [2008], it was 99 to 98. It kind of widened to 97. If the market starts coming back, which I think it will into next year, there's a chance that's going to narrow. People will start doing stuff at a lower OID. I don't see [it going away] anytime soon," the sellside source added.

OIDs dependant on secondary market

Sources also remarked that original issue discounts and low levels in the secondary loan market go hand in hand, and until the secondary bounces back, discounts will continue to be around.

"I don't think new deals can get done here - secondaries are just too attractive. Does a borrower mind selling a loan at 80 with 100 principal? I think there might be tax issues with that for somebody. When the secondary gets back to 85-90, new BB and higher loans with 500-plus coupons can probably get done in the mid-90s," a buyside source said.

"OIDs will remain as long as secondaries are notably below par. Get much below the mid-90s and you are talking loss for the dealers and a weird situation for borrowers. I don't think the primary market will be truly functional until OIDs are three points or less," the buyside source continued.

"With such attractive prices and yields in the secondary, it is hard to make the case to commit to a primary deal. I would imagine OIDs remain at very wide levels throughout '09. For example, Precision Drilling, a high double-B credit needed to lower its OID three times - from the mid-90s to 80," a sellside source added.

Libor floors expected in the threes

Libor floors, according to sources, are also expected to be an integral part of any new credit facility, with the common anticipation being that the floor should be in the 3% to 3.5% type of range.

"Libor floors are likely to stay while Libor is at nominal level. Nobody really wants a 3% total coupon loan, and high-yield managers need coupon to make their dividends, but would like loans to preserve principal. So, 3% Libor floors are likely to remains until Libor is through 3%," a buyside source said.

"They'll be around 3% to 3.5%. You'll see more lenders who are not Libor funders that are concerned about defining Libor, insurance companies or crossover investors that can do bonds or loans. I think they're going to want to have some assurance that declining Libor is not going to get in the way of their returns," a sellside source remarked.

"They're totally standard and they're anywhere from 3% to 3.5%. Libor is down in the low-twos, that's going to be a standard part of any deal for the foreseeable future. If Libor goes up, the floors will move up," a second sellside source said.

"The Libor floors are going to add something to the yield. They're going to add 50 to 100 bps to yield. So if Libor goes up to, which is highly unlikely to happen, 3% or 4%, I think the Libor floors are going to get adjusted accordingly. There will be a limit to it. I think we're going to see 3% to 4% Libor floors so long as Libor stays anywhere under 5%. They're still going to be present in all these deals," the second sellside source added.

Leverage and coverage covenants anticipated

Covenant packages are expected to stay relatively similar to those that are currently being seen in bank deals, with leverage and some sort of coverage requirement seen as the main components.

"A few financial covenants will be standard. Maybe three - total and secured leverage and a coverage covenant. Maybe a couple of new ones will creep in, like ability to buy back below par and how that interacts with free cash flow sweeps and how bought back loans can't be voted by the borrower/sponsor," a buyside source said.

"I think structure and covenants will continue to be a more scrutinized part of credit decisions. Standard leverage, capex, either interest coverage or fixed-charge coverage. I think baskets will be tighter. If you're talking about 2008 vintage deals, all those generally do exist now," a sellside source remarked.

"People are tightening up on covenants," another sellside source said. "The minimum is leverage and fixed-charge coverage. We're seeing a lot of senior leverage covenants and total leverage. We are seeing, in the middle market, minimum EBITDA covenants coming back, which borrowers don't like because it's harder to manipulate EBITDA than leverage. A covenant package that might have been one or two covenants is now maybe three or four covenants and that's just going to stay that way for the foreseeable future, partly because the banks are an important part of the market and they like covenants and they're going to insist on it."

Buyback covenants to enter picture?

Towards the end of 2008, many issuers approached lenders with amendment requests to allow for the repurchase of loans below par, sparking the question as to whether some sort of language will be added to 2009 credit agreements to address that type of situation.

"There have been a lot of buybacks started and more to come. Some were contentious. I heard the LSTA wanted to make buyback language standard in credit agreements but heard no follow up. If the sellside wants to promise a quid pro quo to issuers to win their business, it might be covenants related to buybacks so they don't have to be negotiated one by one. I suspect the buyside would like the deals negotiated one by one, so I only threw that out there as a maybe - the pushback might be too much," a buyside source remarked.

"People would probably rather negotiate it," a sellside source said regarding the possibility of putting a buyback clause in credit agreements. "They have a lot of different aspects to them. Every credit is different, so I think people would probably like to have the ability to approve it at the time. The mood of the market is not to try and provide flexibility. If you want something like that, you have to come to us and request it and we'll do an amendment is we support it or not.

"I do think that credit agreements will, if not accommodate debt buybacks a little more, at least make it clear that it's a majority lender issue instead of an all lender issue," a sellside source responded. "Right now it's just largely unaddressed. It's not contemplated at all in credit agreements. Depending on language, you're going to have the concern whether you can amend it by majority lender issue or an all lender issue. I think what will be clear, if it's not specifically permitted to buyback below par, that you can amend it with the majority of lenders.

"Apart from one really big one, Wynn Resorts, [and] Citadel probably has repurchased a fair amount, you've had some amount of amendments that permit it, but not a whole lot of real activity, people selling to the borrower. I think as long as loans are trading at a discount, it will be something that borrowers would like to have the option to do. I think it will just be clearer," the sellside source added.

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