Bracing for the potential volatility that might follow a UK vote to leave the EU, some banks built clauses into commitment letters that would allow them to change financing terms (including increases to interest rates), if needed, to attract investors.
Even following the leave vote result, some underwriters sought to include features reminiscent of lending terms more common during the most recent credit crisis when a number of banks were forced to hold onto loans they could not sell.
A so-called “Brexit flex” in a commitment letter would allow for higher interest payments if market volatility soared after the June 23 vote, a banker said.
“In times of volatility, the arrangers will want more broad flex language, since they may need to sweeten the pot to bring in lenders,” said Jessica Reiss, co-head of leveraged loan research at Covenant Review in New York. “Potential lenders are often more risk-averse in choppy markets and the ability to adjust certain terms is helpful in building a syndicate.”
Some banks added an extra 25bp to 50bp of flex due to the vote, according to banker estimates.
Underwriters may also have the right to trigger a market material adverse change clause (MAC) due to the referendum that would allow banks to get out of their underwriting commitment due to extreme changes in market conditions.
MAC flexibility related to Brexit may not be available for underwriting commitments made after the results of the referendum became known, which is why banks are being so careful about pricing, said David Campbell, a partner in the banking division of law firm Allen & Overy in London.
The unanticipated result kept Brexit flex language alive immediately after the vote, although volatility has since subsided and relaxed the push to add the protective terms.
After the referendum, at least one bank sought to include a pricing flex keyed off of a loan index, where, if secondary loan trading levels fell, the underwriter could add in additional flex, one banker said. Some banks included this term in commitment letters during the credit crisis.
At least one other bank following the referendum sought to include pricing flex language in their commitment letter that would allow them to transfer unused flex from a loan to a bond, or vice versa; another tactic also used during the credit crisis, a banker said.
The referendum has affected both merger and acquisition transactions, and real estate deals, with some being pulled immediately after the vote, Campbell said.
As volatility in the loan market has diminished in the last week, the need for Brexit flex language has also decreased. Some financings currently in the works, but that may not come to market until September, are being pitched at levels in line with terms available before the vote, and in some cases even slightly tighter, a banker said.
Leveraged loan issuance of US$344bn in the first half of 2016 is down 16% from the same time period in 2015, according to Thomson Reuters LPC data. Low volume has allowed companies to take advantage of demand to come back to the market and lower their interest payments.
”[Banks] are still willing to underwrite, although underwriting terms have moved in the banks’ favor,” said Campbell. “Given the market volatility, banks aren’t prepared to commit to pricing in the way they would before the vote.”
(Reporting by Kristen Haunss; Editing By Michelle Sierra and Lynn Adler)
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