By Lynn Adler
NEW YORK, Jan 25 (LPC) - US high-grade companies, including Bristol-Myers Squibb, are boosting the loan element of multibillion dollar acquisition financings in a move that could stretch some banks’ balance sheets.
Loans are currently cheaper than bonds, which is prompting companies to increase Term Loan A paper and potentially postpone tapping volatile and expensive bond markets.
Floating-rate term loans are also easier to prepay than longer-term bonds and their inclusion could help to address credit rating agency and market concerns about huge debt loads incurred in big corporate tie-ups.
Bristol-Myers Squibb lined up US$8bn in term loans to reduce a US$33.5bn bridge loan put in place early this month to support its US$74bn purchase of Celgene Corp, the biggest ever pharmaceutical tie-up.
These floating-rate term loans, with US$1bn of 364-day, US$4bn of 3-year and US$3bn of 5-year maturities, will reduce the company’s reliance on longer-term bond issuance to replace the bridge loan.
Term loans made up 32.2% of a record US$235bn of US investment grade acquisition loans last year. This is the highest share since the financial crisis, far topping 20.9% in 2017 and a low of 7.4% in 2011, LPC data show.
A record US$140bn of total investment grade term loans were issued last year, up 43% from the prior peak set two years earlier.
Acquisitions are typically funded by bridge loans, which are usually repaid by longer-term debt in the bond market, allowing banks to reuse capital.
Putting medium term loans in place is more expensive for banks, which have to hold additional capital against them and are not able to reuse capital quickly. Costs can rise further in line with bank funding costs, depending on currency.
"Funded liquidity tends to draw more risk premium internally, more risk capital is applied. Some (banks) do it for their best relationships, but others hate it,” a senior banker said.
It could also raise balance sheet risk for banks in a weaker economic environment if credit ratings decline, as the risk of huge BBB rated companies being downgraded to junk continues to rattle the markets.
Acquisition term loans, however, help companies to deleverage more quickly using cashflow, which can protect investment grade credit ratings. They also offer an advantage over longer-term bonds in that they can be repaid with fewer penalties.
“Companies that are entering into transformative acquisitions are often taking on significant amounts of debt. These companies need to convince both the (credit ratings) agencies and the market that the increase in leverage will be short-term and that the company will quickly delever,” said Jason Kyrwood, partner at Davis Polk & Wardwell.
“Term loans, which are prepayable at any time without penalty, offer more flexibility than fixed-rate debt. That is partly why you see large deals like Cigna, Comcast, Bristol-Myers and others include large term loan components,” Kyrwood added.
Moody’s expects a downgrade for Bristol-Myers limited to one notch, to A3 from A2, based on rapid debt repayment that reduces leverage to 3.0x from 4.0x within two years. The rating agency is also looking for a diversified bond offering with staggered maturities.
“If Bristol borrowed the full amount in bonds with longer maturity dates, the pace of deleveraging would be slower, and probably inconsistent with the expected rating of A3,” said Michael Levesque, pharmaceutical analyst at Moody’s Investors Service. “With the term loans, there’s no penalty to pay it down early, and we are expecting them to start chipping away."
TAMING THE DEBT BEAST
Some companies have been slower to repay debt than promised and credit ratings downgrades mounted as debt swelled. The lower ratings further increase borrowing costs.
US companies in the lowest investment grade BBB or Baa categories now account for more than half of the high-grade sector, up from a third a decade ago, due to high debt levels.
Industrial giant General Electric is preparing to unload assets to cut its massive debt load to try to retain investment grade ratings, and global brewer Anheuser-Busch InBev is also trying to protect its rating from sinking to junk status.
Lenders looking to foster strong relationships are willing to provide funded term loan assets to corporate clients, which underscores robust lender confidence in the high-grade market.
“Folding term loans into acquisition financing is definitely a healthy sign,” the senior banker said. “It says that banks have the ability to provide that type of balance sheet risk.” (Reporting by Lynn Adler Editing by Tessa Walsh and Michelle Sierra)