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Leveraged Loans for Take-Overs and LBOs are Back

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Mega-loans for takeovers make comeback

The Globe and Mail [www.theglobeandmail.com]

Published Sunday, Apr. 03, 2011 8:30PM EDT


The return of the mega-loan is driving takeover activity, a clear sign that companies are growing increasingly comfortable with the idea of borrowing heavily in order to fuel mergers and acquisitions in the wake of the credit crisis.

But the willingness of banks to step up and provide large bridge financings for deals, and in some case keep all of the lending business for themselves rather than spread the risk over a syndicate, is also an indication of just how competitive the world of corporate and commercial lending is becoming this year.

The most prominent example came two weeks when U.S. bank JPMorgan Chase underwrote a one-year $20-billion (U.S.) unsecured bridge loan to fund AT&T’s $39-billion purchase of T-Mobile USA from Deutsche Telekom. Such short-term loans which are sought until long-term financing is arranged can be risky if credit markets shift significantly while they are in place.

That mega-loan raised eyebrows in the banking sector for a few reasons. First, it signalled a willingness by AT&T to fund a large portion of the purchase with debt and a return to pre-crisis style borrowing. But it also showed how JPMorgan wanted the business to itself up front, only parcelling off smaller tranches of the debt to a small syndicate of banks a week later.

Canada has seen similar takeovers of late predicated heavily on borrowing, including Equinox Minerals Ltd.’s recent bid to buy Lundin Mining Corp. for $4.8-billion (Canadian), a bid that could be derailed by China Minmetals Corp.’s offer on Sunday for Equinox. Valeant Pharmaceuticals Inc. is also making efforts to tap the debt market in order to fund its purchase of U.S.-based Cephelon Inc. for $5.7-billion (U.S.).

All of this points to increased competition in the banking sector for corporate and commercial loans, which financial institutions in Canada and the United States are looking to for significant revenue growth in the year ahead.

Though mega-loans such as JPMorgan’s have grabbed the headlines, the borrowing market in general is becoming more competitive.

The question now facing banks is how aggressively do they want to participate in what is emerging as a potentially frothy lending market, where covenants are being loosened and rates are coming down in order to compete for business.

“We’re looking to grow, but we’re not going to do so if it means taking on undue risk,” said Laura Dottori-Attanasio, global head of credit products for Canadian Imperial Bank of Commerce.

CIBC has said for the past several months that it wants to boost its position in corporate and commercial lending from No. 5 in Canada to somewhere in the top three. Last week, Richard Nesbitt, head of investment banking at CIBC, told analysts that “we need to be a bigger lender.”

However, no bank wants to move into the risky lending that got the sector into trouble in the credit crisis. Even without the mega-loans seen of late, banks must figure out how aggressively to pursue business, since lending on takeovers is often tied to the long-term relationship a bank has with its clients.

“People see some of these jumbo loans being made and they worry about that,” Toronto-Dominion Bank chief executive officer Ed Clark said last week. “I would say we definitely see on the commercial side, on both sides of the border, that we’re starting to move to structures that are less robust than you would like to see.”

The AT&T bridge financing is a sign that banks are looking to lock down large lending deals themselves. A few years ago, that loan would have been likely parcelled out to a syndicate immediately in order to spread risk among several lenders.

“Even by JPM standards, the size of the financing is big,” said Sean Jones, an analyst with Moody’s Investors Service. “It highlights JPMorgan’s increased appetite for risk.”

Royal Bank of Canada, TD and Bank of Nova Scotia are all major players in corporate and commercial lending in Canada, with CIBC and Bank of Montreal, among others, looking to take away market share. Analysts are watching the Canadian banking sector closely to see if the appetite for risk increases in the competition for lending business.

Brenda Lum, managing director of Canadian financial institutions at bond rating agency DBRS, said corporate lending has grown slowly since the financial crisis, in part because companies have been paying down debt and are borrowing more conservatively these days. That has led to a loosening of covenants and other restrictions in an effort to drum up more loans.

“The growth all-in-all is still relatively modest,” Ms. Lum said. “The challenge is that, given there are loosening of covenants, how much the banks are willing to participate [in more aggressive lending].”

Commercial and corporate loans were $460-billion (Canadian) for the major Canadian banks at the end of the first quarter of 2011, up slightly from $450-billion at the end of the fourth quarter of 2010.

However the lending still trails the $470-billion of commercial and corporate loans outstanding at the end of 2009, and $530-billion at the end of 2008.

Even though CIBC now has a focus on expanding corporate and commercial lending, Ms. Dottori-Attanasio said the bank knows exactly where its comfort zone lies.

“Everywhere in our growth target we talk about judicious loan growth and how our appetite for growth won’t be dictated by fees, but we’re really going to be ensuring that we’re growing in a risk-controlled way,” Ms. Dottori-Attanasio said in an interview

Signs that large corporate lending was coming back with a force after the credit crisis emerged last year when BHP Billiton lined up bridge financing for its $39-billion bid for Saskatchewan’s Potash Corp. Even though the deal never went through, it included $250-million of fees for the group of banks involved.

Equinox Minerals Ltd. is borrowing $3.2-billion to fund its bid for Equinox. That prompted Lundin to advise its shareholders to refuse the offer last week, warning that Equinox was taking on a “dangerous” amount of debt to complete the deal.

Meanwhile, drug maker Valeant Pharmaceuticals Inc. has tapped the debt market in order to fund its bid to buy U.S.-based Cephelon Inc. for $5.7-billion (U.S.). The bid, made public last week by Mississauga, Ont.-based Valeant, would be the largest hostile takeover in the pharmaceutical sector since Genzyme Corp. was bought by Sanofi-Aventis in 2010 for $15-billion. However, that deal was financed by 11 underwriters as banks looked to spread the risks among themselves.

But the strategy of borrowing heavily to fund a deal can be fraught with risks if there is upheaval in the market. That was the case when Teck Resources Ltd. took on $10-billion of bridge financing for its takeover of Fording Canadian Coal Trust in 2008. When the financial crisis hit and credit markets dried up, Teck was forced to sell assets and restructure its debt to get out of the sudden debt crunch it was in.