Douglas Buffone, director and counsel at Credit
Suisse, outlines how the global hunt for yield is impacting US
leveraged and acquisition financing
Year-to-date US leveraged loan volumes total $445 billion, up
from $270 billion at this time last year.
It's thanks primarily to heavy demand from institutional
loan buyers, such as credit funds, pensions, endowments and
collaterised loan obligations (CLOs), for higher-yielding
Credit Suisse's Douglas Buffone explores how sustainable the
market rebound is and explains how demand from yield-hungry
investors is affecting US leveraged and acquisition
Unlike most years, the US leveraged loan market did not see
a big summer slowdown this year, as US issuers took advantage
of declining yields and high levels of demand. To what extent
do you expect this rebound to continue and how is it impacting
In previous years, summer slowdowns have been driven by
developments in external markets, such as the European debt
crisis. But this year there were no big outside shocks to the
system. That said, there is some uncertainty as we go into an
increasing interest rate environment.
Over the past 18 months low interest rates have driven down
yields, and prompted investors to flock to the high yield bond
and leveraged loan markets. There was a similar flood of money
into the system during the last strong cycle of 2005-2007. Back
then money flows were primarily concentrated around the large
numbers of newly created collaterised loan obligations (CLOs).
Today, however, we're seeing increasing activity from a number
of different classes of investor, not just CLOs. This rapid
flow of money from one asset class to another is new to this
cycle. It suggests that investor appetite for leverage finance
risk may not be as stable as in previous cycles.
vital that we establish the rules of the game for all
It's hard to predict how the market will react as interest
rates rise - that is the risk going forward. That said, I still
think that the rest of the year will be fairly strong.
How has investors' re-emerging confidence impacted the US
high yield market?
As mentioned, we're seeing more activity from a much more
varied investor base than during previous cycles. That in turn
is facilitating the speedy movement of resources from one asset
class to another. I'm not sure if this has been driven by
re-emerging confidence, or if it's just another consequence of
the global hunt for yield.
Regardless, as demand increases, the pendulum swings to
borrowers, and borrowers tend to push beyond the usual limits.
There have been a lot more cov-lite deals this year than in
previous cycles, for example, and that's primarily been a
function of demand.
We're in a very borrower-friendly period and that brings
with it not only cov-lite but also other loan agreement
provisions favourable to borrowers, such as looser equity cure
provisions, reduced excess cashflow prepayments and various
other things investors may care about. And while there has been
little change to date in how leveraged finance deals are
getting done, we are beginning to see some innovation in the
market. For example, precaps, a provision that permits a change
of control under certain circumstances, are beginning to be
used to some effect.
Do you expect the Dell LBO will herald a revival of big
In my view, that is not likely.
Certainly, it was rare to see three mega-LBOs announced in
April within just a couple of weeks of each other. The Dell LBO
was the first to be announced. It was followed by Liberty
Global's buyout of Virgin Media and finally the Heinz LBO.
But it's important to remember those deals were all products of
unique circumstances, and their announcement in such quick
succession was probably nothing more than coincidence.
"The rapid flow of
money from one asset class to another is new to this
The Dell buyout, for example, was helped greatly by the fact
the software company's founder, Michael Dell, was behind it.
There were substantial tax benefits motivating the Liberty
Global/Virgin Media transaction, and the Heinz deal was driven
by Berkshire Hathaway's long-standing interest in the food
company. Each deal was therefore motivated by very specific
Undoubtedly their announcement proved it's possible to get a
big deal done, but I don't think we are going to see a series
of them. It's telling that, until recently, there have been no
mega-LBOs announced since, even though the market has been
strong in the intervening period.
I'm confident we will continue to see buyouts announced,
such as BMC Software and Neiman Marcus, but I don't see a flood
of mega-deals of the size common in the 2007 cycle on the
I also expect more acquisitions will be structured as tender
offers following the recent change in Delaware law, which
dropped the percentage of shares needed to approve a short-form
merger from 90% to 50%, under certain circumstances.
That said, I'm not sure we've gone through the complete
legal analysis to date to get banks comfortable with committing
to more tender offers on this basis. Certainly from a legal
perspective, we would want to make sure all the right boxes are
checked. After all, a tender offer is usually more complicated
than a more traditional merger structure. Such transactions
require compliance with both the Federal Reserve and New York
Stock Exchange (NYSE) margin rules, for example. In the latter,
there are certain restrictions on participating margin loans
out to other lenders; while the Fed requires institutional
lenders to register if they purchase margin loans – a
factor which could impact banks' syndication strategies if
lenders are unwilling to cooperate. I don't think we've
explored the legal implications of this rule change in enough
detail as yet.
The 'cashless roll' is being used with increasing frequency
and transparency in US syndicated credit facilities. What are
the consequences of this?This is a really big
concern of mine, and something we as a bank have been on top of
for some time.
We have been doing cashless rolls for several years. But the
mechanism has only really gained prominence in the last six to
eight months, thanks primarily to the concern of certain CLOs
that they are beyond their reinvestment period and thereby are
restricted from investing in new loans. Such restrictions do
not apply, however, if they are simply modifying an existing
This has prompted certain CLOs to request the ability to roll
their position from an old deal to a new deal via an in-kind
exchange, or 'cashless rollover', of existing term loans for
new or amended term loans from the same lender to the same
borrower. For years, this was a mechanism used sparingly. But
in recent months we've seen cashless rolls frequently offered
to all existing lenders in credit facilities being refinanced,
repriced or extended.
don’t think we are anywhere near
pre-crisis levels as yet"
This concerns me for three reasons.
First, it's not clear to me whether or not, in facilitating
such activity, banks are enabling CLO managers to do something
they are not otherwise permitted to do. After all, we have no
obligation to check if such transactions meet the charter
requirements of every CLO that requests this mechanism. But
what if a CLO were to fail? It is possible its investors could
conclude its manager did not have the authority to rollover
their position and the banks that enabled it could find
themselves liable. That might seem a stretch to some, but you
never know what you are going to be sued for.
That said, it is simply not possible to monitor whether or
not each CLO charter document permits this activity, given the
number of permutations involved and frankly the banks don't
want the responsibility of checking. Its permissibility is
going to vary from CLO to CLO and deal to deal. It will depend
too on how many different complications are incorporated in the
transaction. While it might be easy to make the case that a
straight repricing is essentially the same deal with a
different price, that becomes harder when you're completely
changing the security package from first lien to second lien,
Second, US credit agreements do not contemplate cashless
rolls. In a bid to address this, Credit Suisse, along with
certain other large sell-side institutions, are working with
the Loan Syndications and Trading Association (LSTA) to come up
with new form language for our credit agreements that allows
I believe the LSTA is keen to ensure this mechanism is
utilised in a way that protects all the parties involved. It's
vital that we establish the rules of the game for all
Finally, there are a number of potential tax issues relating
to funds' use of this mechanism. For example, it's unclear what
the tax implications are, if on the one hand a transaction is
deemed a cashless roll and on the other it is a refinancing
loan held by the lead arranger for several days.
Credit Suisse has dealt with these issues uniquely, in
requiring those using this mechanism to sign a separate
cashless roll letter that sets out the mechanics of the trade
and thereby addresses the issue that the credit agreement
doesn't permit this. It also asks for reps from the CLO that
this complies with their charter, doesn't conflict with their
organisational documentation and so on. Effectively, this acts
as a release from all parties, to allow us to carry out the
trade for the borrower and the lender without fear of
repercussions at a later date.
I believe some banks have started to incorporate similar
provisions into the actual amendment documentation. But as
every amendment is going to be different, and the provision
becomes redundant if a lender does not opt to use a cashless
rollover, utilising a separate letter is the best approach in
What other pressure points are concerning those active in
the US syndicated space?
Fronting arrangements – and more specifically the
length of time they last – are becoming an increasing
bone of contention among agent banks.
A fronting bank within a syndication usually only takes
pro rata exposure to the borrower but continues to
collect interest from the borrower at the specified rate until
physical assignment of all the loans has taken place. In light
of that, the backstop banks to the agreement would obviously
prefer for this arrangement to be as short as possible.
That has proven to be difficult recently, as more deals come
to market and settlement times increase.
In order to be as transparent and as liquid as possible, the
market needs for these assignments to happen more quickly.
Unfortunately, however, recent deal flow and in particular the
upsurge in refinancings has prompted these assignments to
lengthen as arranger banks' under-resourced operations teams
struggle to keep up. The implementation of longer fronting
arrangements are a direct consequence of that.
The 'Disqualified Lender List' is a further pressure point in
the market. First introduced around six years ago, this
catalogue of blacklisted investors was historically not public
and was limited to excluding certain distressed investors from
acting as assignees on a loan. However, in recent years,
borrowers have pushed the limits in not only expanding the list
to include affiliates of disqualified lenders, but also in
stipulating they do not want these parties as participants in
the loan. What's more, in some cases, the list is no longer
static. In certain credit facilities, the borrower has the
right to update the list after closing. This latter point is of
particular concern to lenders. All of those restrictions are
difficult to police. It also requires the list to be readily
available to the syndicate of lenders in each deal. Clearly, it
has the potential to hinder liquidity in a deal and to disrupt
for leverage finance risk may not be as stable as in
Indeed, it remains unclear what happens to those trades
found to involve a party on the Disqualified Lender List. For
example, some borrowers have stipulated a trade becomes void if
it is found to include disqualified lenders. That's all well
and good, but what happens if the disqualified entity has sold
the loan prior to being identified? Who then owns the loan?
The LSTA is working to address these issues by driving the
implementation of a market standard approach. It's certainly
helpful to have them involved. But as borrowers are not well
represented in the Association, it's hard to say how quickly
this issue will resolve itself.
How has EU sponsors' increasing use of US loans to fund EU
acquisitions affected US loan documentation?
The US loan market is more open than its European
counterpart, and that has prompted a spate of US-financed
European acquisitions. There's a whole host of issues arising
as these two worlds collide. These include legal, tax, and
There are certain provisions within the EU M&A model
that are not found in its US equivalent, for instance, and vice
versa. The European 'certain funds' concept is a good example
here. Derived from the application of the UK Takeover Code in
respect of UK public M&A transactions, it aims to ensure
that the selling shareholders of listed companies have limited
risk as to whether they will receive payment for their shares.
It is not a provision US market participants are familiar
The US Xerox provision is a further example. Named after
their use in the 2009 agreement for Xerox's acquisition of
Affiliated Computer Services, these provisions make clear that
the buyer's payment of the reverse break-up fee not only limits
any further remedies of the seller against the buyer and its
affiliates, but against the lenders as well. It is rare to see
the concept implemented in European transactions.
Even so, I expect these deals will continue to get done and
as more European deals are financed through the US, we should
see a corresponding rise in each market's understanding of the
other's idiosyncrasies. Efforts to accommodate these via hybrid
EU and US-style loan documentation may well follow.
Indeed, this is already something we're seeing in the
market. Going forward, it is likely to play out on a
The rapid increase in loan issuance levels, especially
covenant-lite loans, and more aggressive tone in the market
over the last year have some concerned the US loan market is
rapidly returning to the pre-crisis time period. How warranted
are these concerns?
Certainly, leverage levels have crept up and equity checks
have continually migrated down. Even so, I am not overly
concerned. I don't think we are anywhere near where we were
Leverage levels have yet to reach the same level, and equity
checks have generally not slipped below 20% – those
are some of the factors that we look at. Average deal size is
also not as big as it was. What's more we're not seeing a spate
of mega-LBOs, or at least not to the level that was common in
We also pay close attention to how long our commitments stay
outstanding, how quickly we can syndicate deals and how much
flex we have. Undoubtedly the market has learned its lessons in
terms of mistakes made by arrangers in previous cycles.
Of course, we are in a borrower-friendly environment so we
are seeing more aggressive terms, and there are certainly a lot
more cov-lite deals coming to market. However, cov-lite deals
have historically outperformed covenant-heavy transactions, so
there's an argument that concerns about cov-lite are in part
misplaced. That said, there is a risk that the more cov-lite
deals come to market the more opportunity there is for poor
credits to finance via this route. That could prompt a slew of
cov-lite deals to fail in the next cycle, and thereby produce
worse returns on loans.
Undoubtedly, the market is more aggressive than it was two
to three years ago, but I don't think we are at or near
pre-crisis levels as yet.
How do you expect Basel III implementation and the US QE
taper to affect the US's leveraged and acquisition financing
The QE taper is not going to be good for the leveraged and
acquisition finance markets, although recent Fed statements
suggest tapering will not begin as early as previously
indicated. But equally it is something that is going to affect
the entire banking sector.
I expect Basel III will have a more nuanced impact on
leveraged and acquisition funding.
As Credit Suisse is already a Basel III-complaint bank, its
implementation is not going to impact us as significantly as
some of our competitors. But for those US banks that are not
even Basel II-compliant, the shift to get up to speed with
Basel III requirements will prove immensely challenging. It
will impact how they do deals, and the types of deals that they
are willing to underwrite.
Director and counsel, Credit Suisse
New York, US
Based in New York, Douglas Buffone is a director and
counsel in the legal and compliance department of
Credit Suisse, supporting their credit products,
leveraged finance, corporate lending, portfolio
management and global recovery management groups.
Prior to joining Credit Suisse, Buffone was an
associate with Shearman & Sterling where he
specialised in leveraged bank finance, structured
finance and securitisation transactions. He received a
joint JD/MBA degree from Hofstra University.