Yeah, we definitely need to get this done before the end of the year" – Everyone
It was the common refrain at the end of last year from an overloaded market desperately in need of a holiday – including yours truly, which has meant this “Year in Review”, like many transactions, slipped into early 2022.
But what a year it was. After the rollercoaster of 2020, we saw a strong return to new money deals in 2021. KWM was pleased to support our sponsor, corporate and lender clients on many of the landmark transactions, including EQT’s acquisition of Icon Cancer Care, KKR’s acquisition of ProbeCX, BGH/Abano Healthcare Group’s 1300Smiles P2P, BGH’s acquisition of Hazeldene Chickens, incremental facilities for Icon Cancer Care and APM, IPO financings for Pepper Money and Latitude and Permira/I-MED’s refinancing.
Aussie Term Loan B (TLB) market – who broke the dam?![1]
We’ve been assisting our clients with the development of the Aussie TLB market in recent years since the Apollo/Leighton Services’ Ventia deal in 2014. Uptake was initially limited, prompted by concerns around investor appetite (who are used to seeing, or who require, a maintenance financial covenant), wider flex provisions or the dense (nobody likes a 2 page paragraph) and unfamiliar US-style documents.
2021 can be seen as the year that broke the dam! Our sponsor clients are increasingly pursuing cov-lite TLBs as one of their first choice options. There is plenty to work through upfront in deal structuring, running multiple lender trees, customising US-law and/or US market concepts to Australian borrowers/businesses and Australian law, documentation and syndication. However, sponsors have realised the pain is worth it, with competitive pricing, ability to push leverage and general flexibility of terms.
Most importantly, the depth of local liquidity and range of potential investors has surprised on the upside, with Australian issuers’ AUD TLB borrowings exceeding other currencies for the first year ever and the market for standalone Australian-law governed Australian TLBs (ie not tied to a USD / European tranche nor having to be marketed in the US / European-based investors) coming into its own.
KWM was co-counsel on EQT’s Aussie TLB for its investment into Icon Cancer Care, setting the new benchmark as the largest ever all AUD TLB and the first to pass the A$1bn barrier. We also advised KKR on its Australian law, all AUD TLB to support its acquisition of ProbeCX. Other major Aussie TLB transactions during the year included KKR’s investment into CFS, MIRA’s acquisition of Bingo Industries, MIRA/Aware’s acquisition of Vocus, incremental facilities for Icon Cancer Care under its pre-EQT ownership and 1L upsized facilities for Madison Dearborn’s APM and KKR’s Arnotts.
We firmly expect this trend to continue into 2022 and beyond, with the following key themes:
- Historically the lack of an active secondary market was cited as one of the reasons for the cap on the size of the Australian market. Instead the market expansion last year seems to have been largely driven by increased appetite from buy and hold funds. We continue to watch with interest to see if there will be a corresponding increase in volume and frequency of secondary debt trading.
- Rating requirements have previously been a barrier to entry into the TLB market for some borrowers (from a cost or hassle perspective or both), pushing them towards other products. It’s now clear that unrated Aussie TLBs are possible – which should drive further demand.
- It will be interesting to see how the “battle of the forms” develops. Global sponsors have generally insisted on their “latest and greatest” documentation emanating from the US or Europe. For early Aussie TLBs, arrangers were supportive of using offshore precedent, because the lender universe they were marketing to was accustomed to and more accepting of that approach (and, in the event syndication was struggling, a switch to offshore was possible). As the local market has matured, we’ve seen some arrangers push back on this as they’re now primarily marketing to local financiers who find the US-style documentation and concepts challenging to get across in comparison to the simpler, more familiar APLMA/LMA-style documentation used in this part of the world. Local sponsors and borrowers are also looking for a more easily digestible starting point. The next logical step is for this market to develop new “Australian-style” TLB precedent.
Unitranche is here to stay
Unitranches have continued to prove their value in certain segments of the market. In particular, we see sponsors drawn to the relative speed and ease of execution of a unitranche with a single lender or a club – without the need for a rating (although things are changing on the AUD TLB front) or the risk of a drawn-out TLB syndication period (and the risk of being flexed at the end of it). Others take comfort in the “known quantity” and relationship with their chosen unitranche lenders, compared to a potentially unknown and broad syndicate.
In larger cap deals, unitranche lenders have lost some market share to TLBs, given TLB’s cov-lite nature and the relatively cheaper weighted average cost of a 1L/2L TLB. European and American unitranche markets have adapted by loosening terms and potentially dropping covenants (the “cov-lite unitranche”).
Many unitranche lenders are taking the “if you can’t beat them, join them” approach and being open to participating in 1L/2Ls should this be the sponsor’s ultimate choice of debt product.
Traditional bank debt – quo vadis?
While this development in TLBs and unitranches appears to have taken market share away from traditional bank debt in the larger cap transactions, bank debt continues to play an important role on small to midcap deals. In the large-cap transactions, the inherent advantages of traditional bank debt remain compelling for the right deal – these include:
- tighter pricing
- large committed acquisition/capex lines – which can be challenging to sell to TLB investors
- ability to provide essential services such as hedging, bank guarantees, working capital facilities and other transactional banking lines
In response to the competition from TLBs and unitranches, bank lenders have also fought back by:
- stretching leverage
- offering more flexible accordions
- removing or reducing amortisation requirements
- dropping to single leverage covenant for the right deal.
Long COVID
Like everyone else, leveraged loan markets weren’t totally immune to the continuing impact of COVID during 2021 – particularly for borrowers in exposed sectors like bricks-&-mortar retail, hospitality, travel and leisure. However, unlike 2020, most well advised borrowers were prepared and consent request processes didn’t have the same sense of emergency.
The hardest (and in many cases unanswered) question remains whether borrowers can adjust EBITDA to take into account the impact of COVID-19 (the so-called EBITDA before Coronavirus or EBITDAC adjustment). In 2020 the length of the pandemic and its impacts remained unclear. Nearly 2-years on, some might argue that COVID-19 is now the new normal, while to others the fact the world is still grappling with this one-in-a-century pandemic which continues to throw off new variants just highlights the “extraordinary” nature of it. As new loans are written or refinanced, we’ve seen some borrowers (or lenders) expressly documenting how and when an EBITDAC adjustment can be made and what it covers, others expressly baking in normalisations for COVID-19 “bumps or humps” and equally as many continuing with pre-COVID-19 wording on extraordinary adjustments.
LIBOR transition – the can finally made it to the end of the road
The year kicked-off with a firm reminder from the UK FCA that GBP LIBOR would cease to be available from 31 December 2021 – kicking market participants into action to get their transition project underway. After years of stalling, the market reached a consensus fairly quickly on most of the fundamental points in documentation and GBP LIBOR was quietly farewelled. There’s still work to be done on USD LIBOR before the 30 June 2023 cessation date, but the path ahead is much clearer and we’re seeing loan parties get ahead of this to (hopefully) avoid another crunch period.
Even LBOs are going green
The long term trend towards ESG / Green / sustainability-linked loans (SLL) has been underway for some time, with banks and borrowers building their ESG credentials by linking this to their pricing terms.
However, this was primarily the domain of corporate borrowers – and we’d advised on some of the pioneering deals in this space for Sydney Airport, Ramsay Health, Downer EDI, Estia Health and others.
We are now seeing these features in leveraged financings. In some deals sponsors and lenders have included “agreement to agree” mechanics allowing them to set KPIs once the dust has settled. Others are agreeing the SLL terms upfront with common ESG targets being greenhouse gas emissions and other social targets, EQT’s recent NZ$1bn+ refinancing of its retirement village and aged care business Metlifecare being one such example. We expect this exciting trend to continue given strong supply side and demand side push for more product.
[1] This is an obscure South Park reference that Yuen-Yee insisted we include
