Dealing with tight credit; Part I

As lenders by profession, our panelists want to make loans. All are still in the loan-making business, but they certainly are constrained by the economic realities of this period. All is not doom and gloom, though. They talked about the kind of deals that can be done in this environment and provided some solid advice for broadcasters looking for money.

This year our panelists were: Bruce Levy (BL), Managing Director, Media and Communications Investment Banking, Wachovia Securities Inc.; Jeff Kilrea (JK), Co-President, CapitalSource Finance; and Jim Downey (JD), Manager, Pacific Media Capital LLC. They were questioned by Jack Messmer (JM), Executive Editor, RBR/TVBR, and Mark Fratrik (MF), Vice President, BIA Financial Network.

JM: Let me start out by asking a question of Bruce, since in the past we've had quite a bit of conversation in these calls about how difficult it is to find financing for the low end of the spectrum, but this year there seems to be a little bit of difference.  So let me ask you what the current marketplace is for the large syndicated deals that we've heard may have some problems now?

BL: I'll just quickly address the radio market and then follow up with the TV side.  In general I think that just given the performance of the radio sector particularly the recent performance and estimated performance for '08, the ability for large companies to obtain capital on attractive terms has substantially been diminished.  If you look at some of the spreads of some of these companies in the secondary market, spreads as high as 600, 650 [basis points] over LIBOR for some of the more levered credits, with floors now where the investor has a minimum yield are becoming more common place.  I would say the access to capital, particularly debt capital on the radio side, continues to be under pressure.  There are some positive spots in that the pro-rata bank market, which is you know the old fashion club of banks is doing deals in the 500 [million] to a billion dollar range, but they are at much higher spreads than has been historically attained by the sector.  That is just due to the weakness of the sector. 

On the TV side a little bit better performance.  Still spreads are widening, but with the expectation of a strong political fourth quarter the spreads of that paper tends to be a little bit tighter than in the radio side.  What I would say is it's kind of like an investor strike right now.  People are kind of waiting to see on radio, are okay on TV, but clearly the issuer is not getting the benefit right now.

JM: So in TV you can do deals even up into the billions and find people to buy the paper?

BL: I think that both radio and TV are having a problem on anything sort of greater than a billion cobbling together a syndicate of lenders and that's because the historical market for radio and television the CDOs [collateralized debt obligations] and the CLOs [collateralized loan obligations] are just non-existent today.  The high yield market is basically on strike.  It's essentially waiting to see kind of what happens.  It's expecting a recession and it's saying geez I could buy better paper in the secondary markets.  So there really is very little to no issuance in the high yield side.  So TV, just on a relative performance metric, is attaining better capital, but in general it is very difficult to raise capital in any transactions larger than a billion.  In the billion and less transactions they're going to be bank-only type transactions and they're going to be highly negotiated.

JM: Would you explain the initials for those traditional buyers of the debt?

BL: Yeah it's collateralized debt obligations which is essentially funds that are funded, a lot of them were funded by the sub-prime sector so of course their cost of capital sky-rocketed.  Essentially what you would do is you would put together a pool of loans, get it rated by the rating agencies at a very attractive level and therefore attain a cost of capital that was substantially less and make money on the spread.  Well with the sub-prime sector and the collateralized debt sector being substantially downgraded by the rating agencies, i.e. they did not adequately assess the risk of these pools of capital, the cost of capital for those types of buyers has skyrocketed to the point where it's higher than the return that they can make on their investment.  There is no new capital coming in.  The capital is kind of sitting on the sidelines, but there is just no liquidity in that sector anymore in order to fund LBOs [leveraged buyouts].  Historically that sector has been somewhere around 80% of the leveraged loan market for the big syndications.  Not only has that kind of permanently gone away at whatever attractive rate that was, but the banks which have historically been disintermediated by that capital just don't have the capacity at this stage to go in and commit the dollars to a transaction to get it done in any sizeable level.

JM: What size of transactions are we talking about that have to be syndicated?  Is it everything over 100 million?

BL: I would say everybody is looking for partners today.  The banks' tier one regulated capital ratios are all substantially lower as a result of significant write-downs.  You're going to see probably transactions kind of 125, 100 to 125 maybe have a club of two or three institutions and then it would go on up from there if they could get done at all.

JM: Jeff or Jim how has this been affecting your business?

JK: To echo Bruce's sentiments, I mean putting or cobbling together a bank group of any size when the deal is over 25 million dollars is challenging.  There are fewer people in the marketplace today that are willing to underwrite transactions, so what you're looking to do is partner up or find or establish strategic alliances with other lenders in the marketplace with the hope that each of you will commit to your 25 million dollar share in an attempt to put together a meaningful bank group.  How that's impacting our business-great question.

Along with other lenders we're less excited about underwriting these days, but as it relates to being in communications, specifically, certainly the liquidity in these areas is at, I don't want to call them all time lows, but it's certainly been much less than previous years.  So we're taking a real hard look at whatever credits are available.  We're willing to commit dollars to those credits, but I will tell you the diligence bar is very, very high and certainly the amount of equity support required to get those deals done is probably going up as well.

JD: I'd like to echo the comments that Bruce and Jeff made.  We have mostly played so far in sort of 30 million and below space, so the worst of the credit crunch happened at dollar amounts above some of our most active zone.  Obviously it trickles down.  One concern we have is on liquidity of our collateral. When it gets harder and harder to do a new deal, particularly if the exit plan of our customer is to do a roll up to a larger operator, we can't really count on that happening in this environment.  Secondly, we have to expect that there's going to be a recession in some form this year and while television is likely to escape that bullet because of the benefit from political, radio will be impacted, so a combination of declining earnings and lower multiples among the public markets makes us more cautious for that sector, but we're still very active for the right prospect.

MF: Following up on Jim's comment. In terms of, for all of you, how much has the prospect of the big "R" word, recession, affected your ability to get funding?  Are you predicting or envisioning a short recession in your plans for all your clients, or is more of a longer one year, one and a half year, whatever?

BL: I'll start off with this.  It sounds like there is a lot of parity across the different asset classes.  If you look at radio, I think everybody historically on this phone has a pretty good experience of recessions, whereas historically radio has kind of gone into recession kind of hyper-cyclical and then comes really far back out.  The biggest question I think in radio right now is, are we in a cyclical downturn coupled with a secular downturn?  Clearly radio is perceived to be losing listenership here with a couple of competitors out there.  I think TV is less put in that box, it's less viewed as a secular decline or the secular decline aspect is cushioned by the fact that it's really used as a political medium in a political year.  That is kind of the 64 million dollar question.  That's why radio spreads and the high yield markets and the banks side have widened significantly.  The premium for risk taken in that sector, given the uncertainty on the secular side is being required, it's probably, I don't know if it's an all-time high, but it's pretty close to an all-time high.

JK: My comments are consistent with Bruce's.  I hate to use the "R" word, but there's obviously going to be a slower growth profile attributed certainly to the radio and television sectors and that will be reflected in the leverage multiples that specific operators can and cannot get when comparing that to 2006 and even early in 2007.  And certainly the availability of capital factors into the equation as well.

JD: For television, again, I think the political revenue will offset any new possible recession this year or any expected recession.  If I could express another concern, it would be there's been a 17% drop in audience share among the network television providers as a result of the writer's strike and I'm wondering how easy it's going to be for them to get that back  And if they don't what the long-term impact will be. 

For radio I've noted that we'd expect the multiples have to come down.  We have to expect that stick radios, those that aren't cash flowing, will become even harder to sell. It's sort of an analogy of raw land in a down real estate market.  Also the Consumer Electronics Show this year just seemed to generate a whole lot of devices that compete with radio.  In the past we've seen the eight-track tapes, the cassette tape and each one of those predicted the demise of radio.  Well it didn't happen, but this time for the first time there's going to be convenient handheld devices in the vehicle that will get actually more accurate updates on weather and local traffic.  Long term there's also concern in terms of the listenership levels of radio.  Offsetting that, if HD ever gets traction it's a good product if people, if the industry, can get it installed in their vehicles.

MF: Are there some regions of the country that are doing well economically, that have had a little more success in avoiding the impact of recession, or is it just so widespread in terms of the concern about recession that even decent economic areas are feeling the brunt of this negativism?

JK: I don't think there's any particular area of the country, at least as it relates to our portfolio that's over-performing relative to others.  I think as it relates to radio and television, where we're seeing the greatest amount of success tends to be in the smaller markets where localism, if that's the word, is a paramount requirement for operating a station.

JD: I'd agree the smaller markets have been performing, some of them in double-digit growth, which is very nice to see bucking the overall trend in the industry.  The other exception I would put out there are areas that are growing rapidly geographically or demographically-you know, the Southwest and parts of California where even natural population growth tends to lift the boat even if the industry overall isn't growing.

JM: The smaller markets are doing well now. Is there anything about the FCC's localism proposals and the possible financial impact on smaller markets that worries anyone there? The localism requirements that the FCC is considering, such as full time staffing and some others with cost potential, particularly if they go back to the main studio rule, does that worry you as far as the financial impact on smaller markets?

JK: I'm sure it does, but when we look at pending opportunities I'll strip those into two separate buckets-one being stick projects, or development projects, and the other being, of course, more traditional mature type of projects.  When you look at the mature projects, we're lending based on a multiple of EBITDA or a multiple of cash flow.  If these requirements were to go through, it would first of all have a negative on their operating cash flow, which would have an impact on their ability to service a certain amount of debt.  So the leverage for those opportunities would come down.  It would just be reflected in one's ability to borrow.  As far as developmental projects, it really doesn't have an impact.

JD: The customers I have in that space are already following, if not the letter, the spirit of those guidelines. That's actually part of their success, so I don't see a big change.  It would impact more of the very large operators who are running local stations from a central-casting basis, rather than if they were local and always staying local.

MF: I want to shift a little bit and talk about television. We're going to get through 2008 and everybody's going to count all their money and then it's going to come late November and then the outlook for '09 will be somewhat bleak.  What's going to happen there in terms of financing for deals going forward past this year?

BL: I think everybody is expecting '09 to be a down year, just as historically after a big presidential year the year's going to be down.  I think the result of that is just going to be people are going to be looking at how delevered they want their clients to be by the end of '08.  My guess is you're going to see substantial delevering. They're going to be looking for substantial reduction in leverage, maybe to the tune of under six times, probably more like between four and six, so that they don't count themselves in a very high leverage level going through into '09; which is a big uncertain year.

JK: I would agree with Bruce's comments.  If you just look at historical years following big political years, you tend to see a decent size drop off in cash flow.  Couple that with a slower growth environment-we'll definitely be more conservative with our lending guidelines.

JD: I agree also.  I think there is one possible offset with the digital conversion and undoubtedly some of the better operators will find a way to monetize that extra distribution capability very quickly.  It's hard to put a finger on right now, in terms of that being an offset to the political spending for '08.

JM: Let me ask how the new revenue streams are impacting the TV business?  Are you seeing a lot of operators getting substantial cash from retransmission and/or their digital multicast? 

JD: In terms of retransmission, it's mostly in my experience an offset to the network comp that's dropping away.  Nobody is really doing somersaults in terms of that being a huge benefit, although everybody clearly wants it.  In terms of the digital multicasting, it really depends on whether they've got cable carriage whether they've been able to negotiate it on satisfactory terms or not. Some are monetizing it already. I have one customer in a market where he was able to pick up a second major network affiliate for his digital.  So that obviously is a big benefit.  Others are scrambling to sort of pull together a hodge-podge of older syndicated content and the monetary value of that isn't really clear yet.

BL: There are certain companies out there, Sinclair Broadcasting being one of them, that's been the most successful at getting retransmission dollars.  I think it remains to be seen whether everyone is going to have the ability or the horsepower to negotiate with their cable companies to maximize that opportunity.  If you look at where cable valuations are today, right around six times cash flow, clearly there is not a lot of dollars to give on the cable side, so I think in a tough environment it's going to be hand-to-hand combat to get that.  It's going to be a varying stage of people who are really going to go to the mat. Are they going to potentially try to partner with their cable companies?  That's something that's less than the maximum they can get in order to get ahead of any sort of additional fight three-years down the road.

More next week in Part II.