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| Best M&A/restructuring |
| Providian |
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Date: November 2001 to July 2002 Advisers: Goldman Sachs, Salomon Smith Barney |
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Credit card squeeze: worst S&P 500 |
Providian was the worst performer in the S&P 500 for 2001. Having stood at $59.20 at the end of June, the share price for the US credit card company hit a low of $2.01 at the start of November – a decline of almost 97%.
The problems first manifested themselves when the company reported in its second-quarter earnings in July 2001 that it had been forced to increase write-offs for bad loans.
Providian had relied too heavily for its growth on sub-prime borrowers and was paying the price. Over the next few months the company had to modify earnings guidance and outlook a number of times and for the fourth quarter it reported a loss of $0.76 a share
The rating agencies downgraded Providian several times, taking it from a triple B entity to a single B. The CEO resigned and the company’s regulators stepped in. The Office of the Comptroller of the Currency (OCC) took the lead, imposing on Providian demands for it to rectify its business model and produce a workable capital plan. This was the first of several such outings for the regulators of credit card companies. By the middle of 2002 NexCard, Metris and Capital One had each felt the wrath of their regulators, whether the OCC, the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve or the SEC.
Providian’s problems were the most severe of the four, although NexCard, a relatively new company that touted for business on the internet, was closed down after the FDIC was unable to find parties willing to buy any of its assets.
Providian’s board began to take action in October 2001. It hired Goldman Sachs and Salomon Smith Barney as advisers, forced out the incumbent CEO and, after a search, brought in Joe Saunders, a seasoned and highly respected executive in the credit card business. He was hired at the end of November and the stock rose 15% on the news.
During November the board laid out what it thought it had to do to rectify the situation. Says John Mahoney, managing director and head of the banks and finance banking group at Goldman Sachs: “By mid-2002 the company had pretty much achieved all of its goals.”
Working in the company’s favour was its liquidity situation, which was relatively favourable despite the high proportion of bad loans on its books and the potential increase in funding costs following the downgrades.
“It had good liquidity,” say Peter Aberg, managing director and head of Goldman’s principal finance group. Much of that was in short-term high-quality investments and bank deposits, as well as a lot of unencumbered assets in its portfolio. “So it was able to weather the limited access it had to new funding.” Before the end of 2001 the company issued a $925 million securitized investment-grade bond.
But it still had to fix its balance sheet and business model for the longer term. The decision was taken to reduce substantially the size and scope of its customer base. “They cut off the top and bottom ends of their business, and concentrated on originating a mix of prime and near-prime accounts,” says Mahoney. It would also exit the international markets.
The first step was in mid-November, 11 days before Saunders was hired as the new CEO, when the board announced that it was looking to sell $3 billion in high-risk assets. Investors didn’t seem to have a great deal of confidence in Providian’s ability to conduct a successful sale, as the stock price plummeted 22%. There were no obvious buyers, and no progress was made until mid-2002.
But by January 2002 it was making progress on divesting other parts of the business. JPMorgan Chase bought the $8.2 billion in receivables of Providian’s Master Trust portfolio, which represented the top end of its business. A month later the $565 million of receivables it had in the UK were sold to Barclays Bank, and in March it sold its credit card operations in Argentina. This latter deal was conducted solely by the company; neither of the advisers played a role.
All that was left to do by this stage was to sell the high-risk assets. Unsurprisingly, given the moribund state of the US economy, none of the credit card companies showed much interest. So its advisers stepped up, along with two other investors, Card Works and CompuCredit, to buy roughly $2.4 billion in assets. The deal was financed by a $1.2 billion securitization of the assets.
That solved almost all of Providian’s longer-term issues with liquidity, as well as finalizing its compliance with the regulators. As a result the company was hardly affected by the emergence of problems in the spring and early summer of 2002 at competitors Metris and Capital One. “Last year was all about shoring up the balance sheet,” says Mahoney. “Now they have good liquidity and strong capital, and are concentrating on growing the parts of the business they’re still in.”
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JetBlue: IPO was bright spot in airline sector cloud |
| Best IPO |
| JetBlue |
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Size: $158.4 million Date: April 2002 Bookrunner: Morgan Stanley |
JetBlue went public last year with the kind of deal many thought had been consigned to history. The airline’s $158.4 million offering last April was priced above the range proposed during road shows, closed the first day of trading up 66.7%, and has stayed above its launch price since then. It even managed to provide a small bright spot for the venture capitalist companies that had invested in the firm, although JetBlue was somewhat aggrieved when JPMorgan Partners sold its entire holding once the lock-up period was over later in the year, adding some unwanted volatility to the stock price for a time.
Given the overall state of the airline industry since the September 11 2001 terrorist attacks, the success of JetBlue’s IPO is even more remarkable. Many airlines were reporting losses, seeking government bailouts, and facing sharp increases in the cost of oil and insurance premiums. The only airlines doing well were the lower-cost, fewer-frills airlines such as Southwest. JetBlue fits right into that category.
Good management was also a key selling point, says Josh Walsh, managing director and head of the transportation group at sole bookrunner Morgan Stanley. “JetBlue’s executives are the best of breed in the airline industry and they’ve done an exquisite job,” he says.
Walsh has known the CEO, David Neeleman, for more than a decade. They met when Walsh was advising on the sale to Southwest of an airline that Neeleman once worked for called Morris Air. They have stayed in contact ever since, and Walsh and his team acted as a sounding board for Neeleman when he started to build JetBlue.
Neeleman’s experience and reputation quickly bore fruit. “He managed to get more money as an airline start-up than any other company did,” says Walsh. “You get treated very differently when you turn up at Boeing and Airbus to buy planes if you have a sackful of cash.”
Neeleman and his executives have since built a profitable business that has broad name recognition despite its having just 24 aircraft at the time of the IPO, and 35 now.
The IPO was affected by the terrorist attacks, though. On the morning of September 11, Walsh and his team were discussing plans for the IPO. They were planning to file the company’s intent to go public that week at the SEC. Unsurprisingly, the deal was postponed, and for the rest of the year there was no mention of taking it public. But the company did take the precaution of tapping its private-equity investors for roughly $20 million.
By January 2002 airline stocks started to recover and JetBlue announced good results. The IPO plans were revived and filed with the SEC at the end of February. Walsh and his team took a two-track approach to marketing the deal. First, to specialist airline investors, which was no hard sell. “JetBlue has a cultish following,” says Walsh. “The airline junkies were drawn to the name, just as they were to Southwest and Ryanair. Some had even wanted to invest private equity before the IPO.”
The second track involved marketing it as a brand or consumer product to other investors. “We went for those who would invest in companies with premium-brand names,” says Walsh. “Getting those kinds of investors involved turned it into a fantastic IPO.”
The split between the two groups was roughly 50-50 for the 4 million shares that were sold, amounting to roughly 10% of the company’s stock. The sales by the private-equity firms of much of their stakes later in the year – Western Presidio sold three-quarters of its stake, for example – might have added volatility to the stock price for a while but it also put more of the company into the public market to satisfy demand. Fidelity, for example, now owns at least 12% of the company.
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Offshore oil: Pride staves off short- |
| Best convertible bond |
| Pride International |
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Size: $300 million Date: 26th February Bookrunner: Deutsche Bank |
Puttable convertible bonds were all the rage in the US in the late 1990s, and one-year puts dominated issuance in 2001. The problem was that not every company, and not every bank that underwrote them, gave much thought to what might happen if investors did choose to put them back. As stock prices continued their declines in 2001 and 2002 more and more investors were choosing to exercise the puts. For some issuers this raised the prospect of a liquidity crunch.
Pride International, an oil and gas exploration company, had two such converts outstanding, one issued in 1998 and another in 2001, with the put dates falling in January and April 2003. Last year, having seen several companies forced either to buy back their bonds or to offer investors sweeteners to keep them, executives at Pride decided to act to avoid any potential liquidity crisis at the put dates. They wanted to raise $250 million, $100 million of which would come from First Reserve, a private investor as well as an affiliate and existing stock holder in Pride.
But there was a problem. Pride needed to do an overnight deal that would coincide with the company announcing poor results below analysts’ estimates as well as a significant exposure to Argentina. That would most likely send the stock price down and scupper hopes of raising new funds. Working with Deutsche Bank’s convertible bonds team in New York, the company found a solution.
“Few doubted the longer-term prospects for Pride,” says Brooks Harris, head of convertibles origination for Deutsche Bank in the US. “It was the short-term volatility that was the problem, so we devised a mechanism to take that volatility out of the stock price.”
The solution rested on using First Reserve’s desire to invest in Pride. Rather than having it buy $100 million of any new share offering, First Reserve would instead buy $100 million of stock in the secondary market. One reason for this was to avoid any hint of an existing investor receiving preferential treatment by buying direct from Pride at the same time as a public offering was in the market. Such a large investment ought also to hold off any pressure on the stock after the earnings announcement.
More important, though, was who they bought the stock from. The sellers were convertible investors, or to be more precise hedge-fund convertible investors. They sold First Reserve $100 million by shorting Pride’s stock. They then bought stakes in a new convertible bond that Harris and Pride had set at $250 million. “By shorting the stock and then buying the convertible, the hedge funds were pre-hedged and so largely immunized from any price impact on the stock when the company released its earnings the following day,” says Harris.
In the event, the stock price actually went up, despite the earnings miss and the Argentina exposure, as investors seemed pleased with how Pride had fixed a looming liquidity issue. The deal also had the effect of promoting a strong bid in the secondary market for the two converts with the 2003 puts. This allowed Pride to buy back some of the paper well inside accreted value.
In addition, regular convertible investors showed an interest in the new convertible once they saw that the deal was working, which allowed it to be increased by $50 million.
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GECC: high-grade offering |
| Best high-grade bond |
| GECC |
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Size: $11 billion Date: March 2002 Underwriters: Citigroup, JPMorgan, Lehman Brothers |
Some feel that the most innovative deal GE Capital issued last year was its $1 billion Pines deal, which was the company’s first foray into retail-targeted bonds. But the $11 billion offering last March, the largest ever US dollar corporate bond deal, was the deal that started the whole process of the company diversifying its funding. In this case it was a response to growing concerns that the company was far too dependent on rolling over commercial paper. So GE Capital announced that it was to issue $88 billion during 2002 to rectify the situation. “They were very transparent about what they intended to do,” says Jim Merli, head of high-grade origination at Lehman Brothers. “They had a lot of short-term paper to term out.”
That’s no straightforward task for any company. What made it even more challenging for GE Capital was that it was a relative newcomer both to jumbo and global bonds.
“They had internal limits restricting the size for any single tranche to $750 million, and had only recently increased that to $1 billion,” says a banker who worked on the $11 billion issue. The first deal done without these limits was the $3.5 billion offering of five-year and 10-year paper launched in February.
But the company did have one big advantage – its triple-A rating. “As much as the market had already started to cringe at big issuers and deal sizes, investors went crazy at the news of GE Capital’s decision to raise so much money,” says the banker. “They thought it was the best thing since sliced bread.”
It would make GECC a much larger part of the Salomon and Lehman bond indexes. It also meant that investors would be able to invest in high-quality paper across varying maturities.
“The reason they got it done was that they offered investors the maturities they were looking for,” says Merli. “We were appealing to a very broad investor base.” The $5 billion 30-year tranche proved especially popular, and was four times oversubscribed. “Investors have had very little opportunity to buy 30-year corporate paper, especially from a triple-A name.”
In addition to the 30-year tranche, the company raised $4 billion with a three-year floating-rate note, the largest US dollar floating-rate note ever issued, as well as $2 billion in five-year paper.
All three tranches traded within one or two basis points of the issue prices in the week following the deal, and the spreads on the company’s existing benchmarks didn’t widen. “It’s a whole new world for GE Capital,” says one of the bankers involved in the deal.
| Best corporate bond deal |
| Oncor Electric |
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Size: $1.2 billion Date: May 2002 Underwriter: Lehman Brothers |
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Power plug: Oncor debuts with fall-away security deal |
Last year was not the best time for a company in the energy sector to be issuing its debut debt deal. The Enron debacle as well as problems at companies Dynegy and Williams made for an exceptionally difficult environment for all companies in the sector, even if they weren’t involved in the trading side of the business.
Oncor Electric is all about poles and wires: it was created in 2001 as part of TXU’s plan to separate its generation and distribution businesses, although it is still part of the TXU group. TXU, or Texas Utilities as it used to be called, was to find itself in severe financial difficulties in the latter part of the year – even back in May it was under some pressure.
As a result Oncor and its bankers at Lehman Brothers decided that the best way to get its inaugural deal done at an acceptable price was to structure the offering with what the bankers dubbed a fall-away security package.
In essence, the deal is secured by First Mortgage bonds held as collateral by a trustee. The security falls away once the outstanding mortgage bonds not held by the trustee no longer exceed 5% of the net electric utility property or 5% of capitalization.
The deal was also structured to make the bonds the senior-most debt in the capital structure. “The purpose was to make sure that the bonds couldn’t be structurally subordinated by newer issues,” says Jim Merli, head of US origination for Lehman Brothers, the sole underwriter. “That was critical, as investors have become very concerned about banks getting in front of them in the capital structure.”
So even if and when the security falls away, investors still have a degree of comfort.
These two elements helped to ensure that spreads on the two-tranche deal would not be too wide for the company. The $700 million of 10-year bonds came at 137 basis points over US treasuries, while the 30-year paper, for $500 million, was priced 158bp over treasuries.
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Gap: switch to two |
| Best loans |
| Gap |
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Size: $1.4 billion Date: March 2002 Lead syndicators: Bank of America; Citigroup |
Gap’s $1.4 billion bank line, which was finalized last March along with a convertible bond issue, is a fine example of a company realizing that it is in a difficult situation and needing to act rather than wait to sort things out.
The clothing retailer came into 2002 with sales in decline and near bankruptcy. The last thing it needed on top of that was uncertainty about funding and liquidity. But Gap, says Steve Victorin, head of investment grade lending at Citigroup, “had historically favoured a short-term capital structure for its bank debt”. Its multi-year bank line was for just $150 million, whereas its 364-day facility accounted for $1.3 billion. And that was falling due for renewal in the first two months of the year.
“As sales dropped, the company’s managers realised that they needed to look at their liquidity issues,” says Victorin. “So they had to do something to appeal to their banks and to get in new investors.”
The answer was to cancel the 364-day and multi-year facilities, and instead arrange a two-year secured facility of $1.4 billion.
Having been downgraded in recent months first to BBB and then to BB+/Ba3, the company had to pay up. The undrawn fee was 75 basis points over Libor, and 260bp drawn. “Gap anticipated what it needed to do, did so professionally, and as a result could increase the size both of the loan and convert deals,” says asabove. “The two deals allowed them to restructure, turn business around and go into the 2002 selling season in much better shape.”
| Williams Companies |
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Size: $700 million Date: July 2002 Lead syndicators: Bank of America; Citigroup |
July 2002 was not a good time to be in need of any kind of funding. The collapse of WorldCom in June because of accounting irregularities further spooked investors still reeling from scandals at Enron, Adelphia and elsewhere. Commercial banks were likewise wary of committing themselves to loans to companies with any hint of scandal or financial stress.
Yet one firm that had to get its funding issues sorted out that month was Williams Companies, the telecoms-cum-energy group, whose 364-day bank facility was up for renewal. There was also a new crisis in the energy sector, as it had emerged that several energy traders had been fixing prices. Suddenly trading partners started requiring cash collateral. Yet, despite this and the other problems surrounding the energy sector, the company’s bankers had by the middle of July managed to raise a total of $1.2 billion in commitments to renew the 364-day facility.
Then, just a few days before the deal was due to close, Williams revealed that it would incur a large loss in the second quarter. This kicked in the material adverse change [Mac] clause in the loan contracts, and the banks withdrew their commitments. With $800 million from its 364-day facility due to be repaid or renewed within a week, Williams was facing bankruptcy.
Within a week the problem had been resolved. The bankers, led by Salomon Smith Barney, raised $400 million of new money via a letter of credit, a facility that wasn’t prohibited by Mac clauses, at the same time as restructuring Williams’s $700 million multi-year facility. The latter involved persuading banks in the syndicate to remove a Mac clause so the company would have more room to manoeuvre.
To do that the multi-year facility would become a secured facility, and would be re-priced to pay mark to market pricing. The banks would not agree to help finance the letter of credit without these changes. In addition the syndicate wanted to see Williams raise at least $2.1 billion from asset sales and other financings.
Within a week Williams had agreed and completed the amendments to its multi-year facility, raised $1.4 billion in asset sales and also raised $900 million via a loan secured against some oil and gas properties.
“Williams has always had a loyal following in the bank loan market,” says Chad Leat, head of leveraged lending at Salomon Smith Barney. “And everyone had a common set of economic interests in getting the restructuring done.”
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BofA: groundbreaking credit derivatives deal |
| Best risk management deal |
| Bank of America(Crisp) |
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Size: $300 million in credit derivatives Underwriter: Goldman Sachs |
For an institution the size of Bank of America, last year’s $300 million Crisp credit derivatives transaction wouldn’t seem to be that big a deal. But the amount equates to anything up to a $10 billion risk portfolio, and the concept behind the Crisp deal – it stands for consumer credit reference index securities programme – is groundbreaking.
“Credit derivatives have been used to hedge corporate risk before,” says Joseph Marconi, vice-president of Goldman’s credit derivatives group and the chief architect of the deal. BoA wanted to get protection for some of its unsecured consumer credit exposure in its credit card business. This deal offered the bank a more cost-efficient way of doing so.
“Bank of America wants to manage the risk of its economic capital, to be able to measure it and know its cost,” says Greg Mount, managing director and head of credit derivatives for underwriter Goldman Sachs. “Most banks are only focused on regulatory capital, and there are those that don’t even know how much economic capital they use.”
The first step was to set up two Delaware trusts to issue the triple-B and double-B asset-backed securities that investors would buy. Backing up the securities was an index created for the deal. It consisted of roughly $300 billion in outstanding credit card ABS deals issued by 10 of the largest credit card companies. The index measures monthly net charge-offs on these programmes.
The proceeds from the sale were invested in a triple-A guaranteed investment contract that was wrapped by Ambac Insurance. BoA then bought $300 million in protection against the index from the GIC. If the quarterly average of the net charge off rates in the index increases above a specified level long enough to exhaust the first-loss deductible that the bank has retained, the bank will be entitled to an index protection payment, and investors will lose some of their principal. “This is really a synthetic on consumer credit risk against a dynamic index,” says Mount.
The benefit to Bank of America is more efficient economic capital. “As a highly rated bank looking at all of its portfolios, Bank of America will allocate a lot of economic capital to unsecured loans,” says Marconi.
“This structure allows them to source capital at more attractive levels than alternative sources of funding. The triple-B securities were issued at 200 basis points over Libor, while the triple-A GIC funds at close to Libor flat. Bank of America pays the 200bp spread between the two for the protection. Even if it doesn’t collect any protection payments from investors, this still works out to be a cheaper cost of economic capital for the bank.”
Convincing investors took some time, though. Several initially regarded the deal as a zero-sum game in which BoA was seeking cheap protection at their expense. But, says Marconi, “from the investors’ point of view this transaction provides them with better diversified exposure to credit card risk. And regular credit card deals don’t offer double-B tranches, so it offers a new investment opportunity for those structured product investors who can take on sub-investment grade risk.”
