When ride-hailing app Uber decided that it wanted to raise $1.25 billion in early March, it thought it would take a different route. The firm last tapped the market in mid 2016 with a loan arranged by Morgan Stanley and Barclays. It raised $1.15 billion – slightly less than anticipated – at 400 basis points over Libor from the two banks plus Citi and Goldman Sachs.
This time Uber took things into its own hands. Retaining just Morgan Stanley and only as an adviser, the firm raised seven-year new money directly from the market using its own capital markets team. And it only paid slightly more for it: 425bp to 450bp over Libor. This is despite the fact that an Uber self-driving car hit and killed a pedestrian in Arizona during the syndication process.
The absence of the US banks from this deal is not hard to fathom (non-US regulated Macquarie is acting as CLO intermediary). Uber reported a negative ebitda of $2 billion for 2017 – lending $1 billion to it was never going to sit happily with the lending guidelines for leveraged finance to which the banks have been subject since 2013.
The deal highlights, however, the depth of non-regulated appetite for lending to sub-investment grade corporates and the challenge that this poses for banks.
Recent indications that the US regulators are poised to loosen their rules on leveraged lending could not, therefore, have come at a better time for them. The Office of the Comptroller of the Currency (OCC) seems keen to drop the six times leverage cap for the banks, but this will take time to implement.
“For the guidelines to be scrapped it would have to go before congress, and that isn’t going to happen overnight,” says one observer. “They will keep it as a grey area and see how banks react.”
With caution, in all likelihood.
“My guess is that this isn’t going to be the transformational event that people might think it will be,” says Mark Bamford, head of syndicate at BMO. “We won’t see a sea change in attitude towards transactions – the risk and control apparatus at most firms hasn’t changed.”
What might change, however, is that banks will have more flexibility to challenge direct lenders on deals for which, although they breach the guidelines, they can make a good business case. The regulations allow more leverage on deals that they deem to be credit-improving for the borrower.
“I guess the question surrounds the regulatory back and forth with the OCC and the Fed as to what constitutes a credit-improving transaction,” says AJ Murphy, head of global capital markets at BAML in New York. ”At one point, that was seemingly defined as adding covenants and amortization, and that wasn’t going to happen.”
The result was that banks have seen many deals that they would happily have lent to go elsewhere.
One of the first examples of this was KKR-owned landscaping company Brickman’s acquisition of ValleyCrest in 2014. Morgan Stanley and Credit Suisse did not step up to the follow-on financing from the $1.6 billion they had arranged just six months earlier, when KKR bought the firm, leaving the smaller deal to non-regulated Jeffries.
The hope is that now banks will be in a position to compete, even if the guidelines are still in place.
“We are focused on non-passed corporations that want to do logical things that the market will bear,” reveals another DCM banker. “A year ago, we wouldn’t do a TLB [Term Loan B], but we will do one now,” he says.
The truth is that the return of volatility to the market since February might be doing the regulators’ job for them.
“When you need the regulator to dampen the excesses of what the market will do is at the beginning of the bubble,” points out one leveraged finance expert. “Where we are today, the need for regulation has started to recede. A year ago, banks might have needed to be reined in, but now everyone is feeling a bit more cautious. So at the end of a bull run, this is less of a concern.”
The weaker end of the sub-investment grade market is unlikely to become an active hunting ground for US banks even if the OCC continues to indicate that they will not be restricted to the same extent as they have been in the past. Indeed, many believe that the environment will be tougher for lower-rated credits.
In late March, Barclays, HSBC and JPMorgan were lining up banks for the €6.5 billion funding for AkzoNobel’s sale of its specialty chemicals business to Carlyle and GIC of Singapore – a deal with a 6.4 times leverage multiple.
“There will likely be greater bifurcation in the leveraged finance market between the better deals, which everyone will go for, and more challenging deals, which will be disproportionately tough,” says Murphy.