Presentation to the Carlow Kilkenny Skillnet Deloitte Debt Advisory April 23 rd, 2013
Topics Covered 1. The Banking landscape in Ireland today 2. Managing your existing Banking relationship 3. Evaluating debt service and repayment capacity 4. Alternative sources of Finance 5. Restructuring Options 6. Outlook for Irish Banking
Current Irish Bank Debt Market
Current Bank Lending Market All banks operating in the Irish market still have a strong appetite for exposure to the low risk, large corporate and semi state market. New lending to the Irish mid corporate/sme market remains challenging however new lending has become more accessible over the last 6 months mostly due to AIB re-entering the market. BoI remain active whilst UB s appetite is limited to certain sectors. Where available, typical lending criteria to the mid corporate/sme market includes: Composite debenture with full cross guarantee structure; 3-5 year term; Debt amortises over the term with very little refinance risk on maturity; Max senior debt c. 3.0x 3.5x EBITDA with interest cover > 3x; and Senior priced at circa 3.5%+ with arrangement fees. Banks will lend against property, but property must be income generating with a strong lease. Typical lending criteria is: 50% to 65% loan to current market value; Greater than 2 times interest cover; Surplus income is used to amortise debt.; Term is 5 to 7 years but amortisation profile is based on a 15 to 20 year period. BOI Commitment to meet its 4.0bn lending target. Focus is on trading businesses. AIB Committed to meet its 4.0bn SME lending target. Focus is on residential mortgages and SME s. UB/RBS Lending to the corporate and semi state market, and to the mid corporate/sme market. Barclays Lending to the Irish large corporate and limited investment property deals. Close Brothers Specialist in leasing and invoice discounting. Looking to expand in the Republic of Ireland. Anglo/IBRC In liquidation through the Special Liquidator. BOSI/Certus The book is being wound down. No new lending. Rabo Bank Appetite for new lending into Food & Agri sector. NIB/Danske Limited appetite for new lending in Ireland. Banks are viewing lending as part of an overall relationship i.e. no longer a standalone product. The potential for other income streams is considered key to getting approval for the debt facilities e.g. deposits, cash collections, foreign exchange etc. HSBC Limited appetite for new lending in Ireland.
Competition in the Banking Sector Few active players left in the Irish banking market. Competition varies greatly depending on the category: Large Corporate and Institutional Mid Corporates (c. 20m c. 250m turnover) SME Property Competitively banked. BoI, AIB, UB/RBS, Barclays, Rabo, BNP, HSBC and Danske are all actively looking for new business. Private placement bond market becoming increasingly popular. Category seen as low risk with most businesses cashflows heavily weighted towards exports. Currently under banked. BoI, AIB and UB, are the only active lenders. Badly hit by the withdrawal of BoSI and Anglo. Due to their lack of scale, the overseas Capital Markets are not available as a source of funding. NPRF sponsored funds will help to provide a alternative source of funding to this sector. Politically sensitive. Difficult sector to lend into, particularly in a recession. Significant Government pressure on the Covered Banks to lend into the sector and some recent indication that this is happening. NPRF sponsored funds will help to provide a alternative source of funding to this sector. Issue remains that a lot of companies in this category are under capitalised. All Irish banks remain overweight in this sector. Will lend against well let income generating assets but focus is on cash generation rather than market value. Banks are not willing to write any new business in this sector above 65% loan to value ( LTV ) unless it is part of a debt recovery strategy.
Managing Your Banking Relationship
Relationship Banking Borrower and Lender will have their own set of objectives however a strong working relationship is based on finding the common ground Borrower Stability and certainty Access to funding / credit lines Quick decision making process and access to decision makers Funding package that reflects the profile of the business Leaves management get on with running the business i.e. no onerous conditions Will work with management if the business underperforms Lender Stability and certainty Good quality information Full banking relationship to maximise overall share of wallet Clear repayment strategy If the company is stressed clear exit strategy that demonstrates why existing management are best placed to maximise the Banks recovery Minimise losses and timeframe to exit Key Considerations No surprises! Provide relevant financial information Provide solutions
Evaluating Debt Service and Repayment Capacity
Trading Business Cashflow Lending Introduction Preference of Irish banks is a cash flow lend as opposed to an historic valuation/balance sheet lend. A debt raise / refinance will be predicated on the debt service capacity/trading cash flows of a business. Example ABC Ltd is services company with short term contracts from its main clients but has been in business for 20 years. The company employs over 200 people and has continued to generate strong profits despite the recession. ABC Ltd currently generates c. 3m in EBITDA and c. 2m in free cash. Illustrative New Facilities: Senior Debt max 3.5x EBITDA ( 10.5m); 5 year term; COF illustrative at 2%; Margin 3.5%; Interest cover > 3.5x; DSCR > 1.3x; Annual cash sweep above a retained minimum 100k cash reserve; Very little refinance risk at maturity. ABC Ltd '000 2013 2014 2015 2016 2017 EBITDA 3,000 3,000 3,000 3,000 3,000 Working Capital (100) (100) (100) (100) (100) Capital Expenditure (850) (850) (850) (850) (850) Tax (50) (50) (50) (50) (50) Free Cashflow 2,000 2,000 2,000 2,000 2,000 Interest (578) (499) (417) (330) (238) Scheduled Capital Repayments (962) (1,039) (1,122) (1,210) (1,301) Surplus / (Deficit) 461 461 462 461 461 Opening Cash 100 100 100 100 100 Cashsw eep (461) (461) (462) (461) (461) Retained Cash 100 100 100 100 100 Closing Debt 9,078 7,577 5,993 4,323 2,561 Senior Debt / EBITDA 3.0 2.5 2.0 1.4 0.9 Interest Cover 3.5 4.0 4.8 6.1 8.4 DSCR 1.3 1.3 1.3 1.3 1.3 Source: Illustrative Workings
A Property Asset / Company Property Based Lending Property Company This market has been impacted quite negatively over recent years as property values have reduced sharply. Interest only loan, prevalent during the property boom, are no longer available. Change in tax legislation, including the rescinding of some capital allowances, has meant borrowing in personal names is no longer tax efficient. New funding's and refinancing's are being done mostly through corporates and tax efficient vehicles e.g. Qualifying Investment Funds ( QIF s ). Based on recent experience in the market, our assessment of the key property lender metrics are currently: Loan to Value (LTV) of 50% - 65% based on current market value; Interest Cover greater than 2x; and Surplus cashflows are to be used to amortise debt. Prop Co Ltd '000 2013 2014 2015 2016 2017 Net Rent 6,000 6,300 6,615 6,946 7,293 Interest (1,980) (1,814) (1,629) (1,423) (1,196) Taxable Rents 4,020 4,486 4,986 5,522 6,097 Tax (1,005) (1,121) (1,246) (1,381) (1,524) Surplus / Deficit 3,015 3,364 3,739 4,142 4,573 Opening Cash 100 100 100 100 100 Cashsw eep (3,015) (3,364) (3,739) (4,142) (4,573) Closing Cash 100 100 100 100 100 Closing Debt 32,985 29,621 25,881 21,740 17,166 Senior Debt / EBITDA 5.5 4.7 3.9 3.1 2.4 Interest Cover 3.0 3.5 4.1 4.9 6.1 Source: Illustrative Workings
Alternative Sources of Finance
Alternative Sources of Capital Increasing number of domestic and foreign funds looking to fund deals in the corporate space. Funds will invest through equity, mezzanine debt and senior debt. Investment is typically IRR driven however some funds are prepared to take a longer term view. Selected Providers Offering Targets/Strategies NPRF Funds: Bluebay Cardinal Better Capital Senior/Mezzanine/Uni-tranche Equity Equity/Bridging Underwrite Performing trading businesses Promote M&A and growth strategies Stressed and distressed businesses PE Firms: Sankaty Columna Capital QED Equity Sandton Capital Full capital stack Stressed and distressed trading businesses. Preference is to acquire debt on a loan to own basis. Portfolio Acquirers: Santaky Apollo Kennedy Wilson Blackstone Cerberus LoneStar Large portfolio acquirers. Mixture of sell on, loan to own and loan to hold.
NPRF Funds 3 funds aimed at credit starved SME s Fund Manager Capital Avaialble Size Target Market SME Credit Fund BlueBay Asset Management Debt, Senior & Junior including uni-tranche 500m Larger SME s and mid-sized corporates Overleveraged firms too much debt but viable businesses SME Equity Fund Carlyle Cardinal Equity 300m - 350m Healthy businesses and firms with heavy borrowings that need cash to grow SME Turnaround Fund Better Capital Equity 100m Underperforming businesses at point of insolvency but have the potential for financial and operational restructuring C.40% of capital invested will be used to buy the business and c.60% to finance the turnaround
Restructuring Strategies
General Approach Current Debt Stucture and Asset Values Example Company 180,000,000 160,000,000 140,000,000 120,000,000 100,000,000 80,000,000 60,000,000 40,000,000 20,000,000 - Current Senior debt c. 95m currently out of the money Valuation Value breaks at 60m of existing debt Example company current capital structure and current asset values is set out on the chart opposite. As can be seen, current market value is 60m. Total senior debt is c. 155m. Based on this valuation the current LTV is 258%. Value breaks at 60m of senior debt, which shows an indicative c. 95m out of the money. It is evident from the above that the current capital structure and associated interest costs, combined with the difficult trading environment, is not sustainable and constrains any further development / investment in the assets. Capital structure should be right sized to the CMV of the assets. Potential Capital Structure 70,000,000 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 - Right sized senior debt @ 60% LTV Capital Stucture Valuation Debt levels 3.0x 3.5x EBITDA or 50/65% LTV; Any new investment would expect to be investing at a super senior ranking or subordinate to a portion of the existing senior debt, but still in an in the money position. Given the risk profile of this new money investment a target return IRR in the mid-teens to high-teens is standard in the current market. Once a more appropriate capital structure has been implemented and a right sized balance sheet has been achieved, stakeholders can focus on enhancing cash flow and asset values. Right sized debt Finance Gap - Equity / Asset Sales
Outlook for Irish Banking
Future Competition in the Banking Sector It is pivotal to the survival of the Irish banking system that a healthy level of competition returns to the market We are seeing a return to an Irish banking sector dominated by two main players Bank of Ireland and AIB. However Ulster Bank are one of the few institutions lending again and view the current environment as an opportunity to increase market share. AIB may become an acquisition target once it has been stabilised. If this happens the new owner will have a strong influence on how the banking market in Ireland evolves. Strong case for the Government to set up a new business friendly bank along the lines of the old ICC Bank plc. Foreign banks in Ireland like Barclays and HSBC will continue to lend into the market but will remain focused on large corporates and institutions.
Increasing complexity of debt products and financing structures for Corporates Increasingly complex financing structures have meant the addition of stakeholders with disparate interests Debt - bilateral Equity Management Pension Trustee Multi layered Debt: Senior Junior PIK Super senior Note holders Issuer Security trustee Swap counter parties Note trustee
Property Funding in the Future Property lending criteria will continue to be more stringent Characteristics of the new property funding market will be: Consistently lower levels of lending for the purposes of property development; Banks will continue to withdraw from debt funding land banks; Significantly higher levels of securitisation and, as a result, commensurately lower loan to values ( LTV ) in investment deals. Current required LTV s are under 50% with strong interest cover; Security quality will become a key issue and fixed assets will be supplemented with guarantees and indemnities; Margins will be notably higher as a result of increased perceived risk; Borrowers will be required to commit higher levels of their own funds to any transaction and applications for new funds will be analysed in the context of the Borrower s entire exposure both to institution in question and to other institutions. Unsecured Personal Guarantee s ( PG ) will become less of a feature in future banking deals. Up front cash investment and/or additional tangible security will be required. Overall unsecured PG s did not work for Banks and / or Borrowers.
Basel III There has been a mixed reaction to Basel III in Europe with industry experts in disagreement as to how effective it will be. Tier 1 Capital Ratio Capital Conservation Buffer Countercyclical Capital Buffer Capital for Systemically Important Banks 6% Tier 1 Capital ratio 2.5% of RWA 0% - 2.5% of common equity Liquidity Coverage Ratio TBA The Irish Financial Regulator set out a basic 8% Core Tier 1 requirement for Irish banks, higher than the 6% Core Tier 1 requirement under Basel III a January 2014 is the current target start date. Noah Millman (The Economist) criticised Basel III for several reasons: NM believes the biggest weakness is the concept of risk weighting which is backwards looking and assumes that securities which have been risky in the past are the same as the securities that will be risky in the future; It also opens up potential gaming of the system; As a result of this risk weighting, Basel III effectively doubles down on Basel II, and banks will need to hold more common equity than ever against their risk weighted assets; Additional measurable risk taking is now stigmatised and the game becomes how to increase returns without increasing measurable risk.
Deloitte Debt Advisory
Debt Advisory Independent financing advice Why our clients use us Our team Conflict free independent advice We are independent of capital; therefore our advice remains truly independent and aligned in assisting our client to reach their objectives throughout the process Michael Flynn Partner Tel: +353 1 4172515 E: micflynn@deloitte.ie John Doddy Director Tel: +353 1 4172594 E: jdoddy@deloitte.ie Financing expertise Full service offering We have a detailed knowledge of the Irish banking market and an up to date insight into the workings of the main institutions including NAMA. Through the Deloitte network we have access to market leading expertise and execution resources. We have in-house specialists focusing on all the areas of relevance to you including: debt advisory, financial and operational restructuring, tax, valuation, M&A, derivative structuring and valuation, accounting and sector expertise. Ferga Kane Director Tel: +353 1 4172534 E: fkane@deloitte.ie Shane Woods Senior Manager Tel: +353 1 4173666 E: shwoods@deloitte.ie Breandan Ó Callarán Manager Tel: +353 1 4175721 E: bocallaran@deloitte.ie
Debt & Capital Advisory What we do Corporate REI / E&R FS New Debt / Refinancing Restructuring Real Estate Debt Solutions Infrastructure Deleveraging New Debt requirements e.g. M&A activity, new projects Maturing Debt facilities which need refinancing Existing lender in wind down (IBRC / BOSI) or not functioning Considering accessing new debt markets Real or potential breach of covenants Restructuring of existing stressed debt structures e.g. overleveraged LBO Existing lenders transfer debt to an alternative lender group at par or discount to par Presentation of credible plan to lenders Structures to satisfy lenders but maintain value opportunity for borrower in future Asset and loan sale / purchase for PE Firms / Borrowers New projects e.g. energy / renewables, PPP Refinance of existing facilities Secondary market Alternative sources of funding e.g. pension funds Develop detailed deleveraging strategies Loan portfolio sales Loan purchases Financial adviser to a Cork based SME Project Timber Raise new Term and WC debt to refinance IBRC Borrower discounted debt buyback from IBRC and Ulster Bank Negotiate restructure of existing debt and bonding obligations and negotiate an inter-creditor to govern same Debt advisory services and project funding Sell-Side Advisory Corporate & SME Loans Ireland 13 million 204 million c. 100 million 601 million 2.5bn
Deloitte Debt Advisory Why clients use our team Four situations typically trigger our involvement: Refinancing Restructuring or renegotiating Acquisitions, disposals, mergers FX and interest rate risk, cash and liquidity management Maturing debt facilities Rapid growth and expansion Accessing new debt markets Asset based finance to release New money requirement Real or potential breach of covenants Short term liquidity pressure Strategic acquisitions, involving new lenders and greater complexity Staple debt packages to maximise sale proceeds Operations in multiple jurisdictions and currencies creating FX exposures Review of FX, interest rate and commodity risk value Credit rating downgrade Additional finance required as management strategies Off balance sheet finance Assessing multiple proposals from lenders Cash management requirements to enable efficient debt service Existing lenders transfer debt to an alternative lender group Derivatives in place and/or banks hedging requirements to be met a result of a change in strategic objectives FX impacts that need to be reflected in the covenant definitions Foreign currency denominated debt or operations in multiple Cash in multiple companies, accounts, countries and currencies Hedging implementation or banks hedging requirements to be met currencies Depth and breadth of expertise in a variety of situations
Service Offering by Target Client Group ISSUE CLIENT GROUP SOLUTION / SERVICE Refinance: Upcoming refinance event Over reliance on bank funding Banking group not functioning New Funding Required: Funding Growth Funding M&A Cash management/treasury Performing Large Corporates Commercial Service States Top 150 / PLC s Mid Corporates SME s Options Appraisal Report Advice to Company Board Capital Raising Strategies utilising the Deloitte Global network Syndication /Clubs/Inter-creditors New funding sources including Private Placements and Bonds Cash management solutions Create competitive tender process between funders Negotiate improved terms Stressed Refinance: Real or potential covenant breach Upcoming refinance event Refinance not fundable in debt market Decouple trade from property debt overhang Existing bank winding down Banking group not functioning Debt sold to PE Fund Stressed Large Corporates Commercial Service States Top 150 / PLC s Mid Corporates SME s Negotiate Standstill Options Appraisal Report New Money (Incl Private Equity) Disposals (Whole / Part) Debt Write Down Debt for Equity / Subordination Negotiate Inter-Creditor Debt Buy Back OpCo / PropCo structure Management Incentive Schemes
Service Offering by Target Client Group Contd. ISSUE CLIENT TYPE SOLUTION / SERVICE Stressed Refinance: Potential event of default Refinance not fundable in debt market Bank sweeping cash creating unpaid tax liabilities Debt sold to PE Fund Stressed Personal Borrowers with debt > 10m but remain High Net Worths Negotiate Standstill Options Appraisal Report Advice to Borrower through process Restructure into Corporate/QIF Negotiate restructure / buy back Source new funding High loan to deposit ratios Large Non-Core Loan Portfolios Pressure from Troika to deleverage Deleveraging Banks Work with FSA and UK FSA Data remediation Advise on portfolio sale process Sell portfolios Refinance: Upcoming refinance event New Funding Required: PPPs Funding Growth Renewables / Energy Infrastructure Finance Advice to Borrower Capital Raising Strategies New funding sources Hedging Strategies Create competitive tender process between funders Negotiate improved terms
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We have what it takes to close the deal The disposal of AIB International Financial Services to Capita Group plc The disposal of a 51% stake to OCS Ireland Ltd. The acquisition of the milk and agri stores business of Donegal Creameries The acquisition of Interfusion Networks Ltd, a network management services company The disposal of the business of OCS Nederland BV, a contract cleaning service provider, to CSU Total Care BV. The disposal of the company to Bacharach Inc. The acquisition of the Irish brands of Premier foods, including Gateaux, Chivers, Erin & McDonnells The acquisition of Premier Periclase Limited from CRH plc The disposal of 50% of FBD Property and Leisure Ltd. The acquisition of a majority stake in the City Bin Company The disposal of the company to Zeus Packaging Limited Venture capital and private equity funding round The disposal of the company to Vodafone Venture capital and private equity funding round Venture capital and private equity funding round The disposal of The Irish Catholic Newspaper to Management The proposed acquisition of the wholesale and pre-wholesale business of Cahill May Roberts The acquisition of the Thyssenkrupp Construction Group The acquisition of Statoil Fuel & Retails Industrial LPG business in Sweden & Norway The merger of Jacob Fruitfield Group and Valeo These are some of the companies we have worked with recently. Deloitte, one of the world s leading professional services firms, combines expertise in M&A services with leadership in business strategy to ensure the smooth and successful transaction of major corporate deals in Irish business. Please call (0)1 417 2200 or visit www.deloitte.com/ie for further information
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