NEW YORK, Jan. 25 (LPC) – Blue-chip US companies, including Bristol-Myers Squibb, are bolstering the lending element of multibillion-dollar acquisition finance, which could stretch the balance sheets of some banks.
Loans are currently cheaper than bonds, prompting companies to increase A-term loans and potentially postpone exploiting volatile and expensive bond markets.
Variable rate term loans are also easier to prepay than longer-term bonds, and their inclusion could help address the concerns of rating agencies and the market about the huge debts incurred during large company mergers.
Bristol-Myers Squibb put up $ 8 billion in term loans to reduce a $ 33.5 billion bridging loan put in place earlier this month to support its $ 74 billion purchase of Celgene Corp, the most great pharmaceutical merger ever.
These variable rate term loans, with US $ 1 billion at 364 days, US $ 4 billion at 3 years and US $ 3 billion at 5 years, will reduce the company’s reliance on issuing bonds at longer term to replace the bridging loan.
Term loans accounted for 32.2% of a record US $ 235 billion in quality acquisition loans in the United States last year. This is the highest share since the financial crisis, far exceeding 20.9% in 2017 and a low of 7.4% in 2011, according to LPC data.
A record US $ 140 billion in investment grade term loans were issued last year, up 43% from the previous high set two years earlier.
Acquisitions are typically funded by bridging loans, which are typically repaid by longer-term debt in the bond market, allowing banks to reuse capital.
Setting up medium-term loans is more costly for banks, which have to hold additional capital against them and are unable to reuse the capital quickly. The costs can increase further depending on the bank financing costs, depending on the currency.
“Funded liquidity tends to attract more risk premia internally, more risk capital is applied. Some (banks) do it for their better relationships, but others hate it, ”said a senior banker.
It could also increase the balance sheet risk for banks in a weaker economic environment if credit ratings drop, as the risk of huge BBB-rated companies being demoted to junk status continues to rock the markets.
Acquisition term loans, however, help companies deleverage faster by using cash flow, which can protect investment grade credit ratings. They also offer an advantage over longer-term bonds in that they can be redeemed with fewer penalties.
“Companies that embark on transformative acquisitions often incur significant debt. These companies need to convince both the (credit rating) agencies and the market that the increase in leverage will be short-term and that the company will get out of debt quickly, ”said Jason Kyrwood, Partner at Davis Polk & Wardwell.
“Term loans, prepayable at any time without penalty, offer more flexibility than fixed rate debt. That’s part of why you see big deals like Cigna, Comcast, Bristol-Myers and others include long-term loan components, ”Kyrwood added.
Moody’s expects Bristol-Myers downgrading limited to one notch, from A3 to A2, based on rapid debt repayment that reduces leverage to 3.0x from 4.0x in two years . The rating agency is also looking for a diversified bond offering with staggered maturities.
“If Bristol borrowed the entire amount in longer-dated bonds, the pace of deleveraging would be slower and possibly inconsistent with the expected rating of A3,” said Michael Levesque, pharmaceutical analyst at Moody’s Investors Service. “With term loans, there is no penalty for prepaying them, and we expect them to start cutting back. “
LEARN THE BEAST OF DEBT
Some companies have been slower to pay off debt than promised, and credit scores have deteriorated as debt has swelled. Lower ratings further increase borrowing costs.
U.S. companies in the lowest investment grade BBB or Baa categories now account for more than half of the top tier industry, up from a third a decade ago, due to high debt levels.
Industrial giant General Electric is preparing to offload assets to reduce its massive debt load in an attempt to maintain investment-grade ratings, and global brewer Anheuser-Busch InBev is also trying to protect its rating from going trash.
Lenders looking to maintain strong relationships are willing to provide funded term loan assets to corporate clients, which underscores the lenders’ strong confidence in the high quality market.
“The consolidation of term loans into acquisition financing is definitely a sign of good health,” said the senior banker. “He says banks have the capacity to provide this type of balance sheet risk.” (Report by Lynn Adler edited by Tessa Walsh and Michelle Sierra)