Transactions Blog

Introduction

29.983.000.000 EUR (5,2% of GDP), that is the number on which the Dutch government’s deficit landed in 2010.[1] In order to seal this gap, the Dutch government recently announced a plan containing a variety of structural measures to save up to € 18 billion between 2012 and 2015.[2]

Specific for the M&A field, one topic catches the attention: the restriction on the deductibility of interest on acquisition debt in a fiscal unity as from 1 January 2012.

What does it mean?

Under the current legislation, it is common practice that following an acquisition the leveraged acquiring company (holding) enters into a fiscal unity with the former Target, mostly an operational entity. The fiscal unity provides that income and cost from both companies can be offset against each other. Doing so, the tax base of this Dutch operational Target erodes due to a ‘debt push down’.

The new law wants to discourage such constructions. It imposes that the interest cost relating to the acquisition debt can only be offset against the taxable income of the acquiring (holding) company to the extent it does not exceed the taxable profit of this acquiring (holding) company. It will no longer be possible to offset the interest expenses of the acquisition debt against taxable profits of the acquired company. Hence, due to this exception on the Dutch fiscal unity a ‘debt push down’ will no longer be realised.

 The amount that is not deductible is the lower of (i) the excess interest expense minus 1m EUR or (ii) the result of the formula: total acquisition interest expenses * (excess debt / total acquisition debt). The amount that could not been offset in a given year can be carried forward.

Exceptions

The interest cost of the acquisition debt remains deductible when the debt/equity ratio of the fiscal unity does not exceeds 2:1 or, as mentioned above, when the interest cost of the acquisition debt is less than 1million EUR.

Conclusion

In order to safeguard the tax deductibility of interest on acquisition debt, proper debt structuring is (and remains) key.

P.S. Other measures

It should be pointed out that the Dutch Budget 2012 also includes proposals in respect of (i) the Dutch tax exemption on non-Dutch permanent establishments, (ii) substantial interest rules (ii) and dividend withholding tax relating to Dutch Cooperatives.

Further information can be found on: http://www.pwc.nl/nl/prinsjesdag/index.jhtml

Despite previous uncertainty in the debt markets, Central Banks continue to be proactive to limit the chances of a double dip recession. The UK corporate loan market was lifted by the return of large cap M&A, with banks providing strong support for BHP Billiton’s bid for Potash Corp through a US$45 billion loan facility. Strong, positive momentum in the leveraged market during September bodes well for the remainder of the year.

Competition from the bond market is pushing up total debt multiples, in some cases to over 5x, whereas in the mid market total leverage is typically up to 4.25x. The corporate bond markets rebounded after the short lull in Q2 and our view is that the bond markets will continue to increase their overall share of financing activity.

In contrast to these buoyant levels and the recovery in leveraged finance, other credit markets are more subdued. This issue has a special focus on Project and Infrastructure Finance where despite a long-term need for infrastructure projects, demand for new finance has been dampened in the short-term.

Simon Boadle, Head of Debt Advisory, said “Despite specific issues in certain sectors, sentiment in the credit markets has generally improved and the short term outlook for the availability of debt finance is positive.”

For more details, check out the latest Debt Markets update from our UK colleagues -  Debt Markets Update Autumn 2010

UK corporate lending was therefore relatively quiet in Q2 with borrowers and lenders alike waiting for the outcome of the UK’s general election and emergency budget. There has been a steady flow of new Leveraged Buyout (LBO) deals over the last six months, but we should not forget activity levels are the lowest since the late 1990’s.

On the debt restructuring front, payment defaults and new formal restructuring discussions are substantially lower than a year ago, covenant resets less so. This perhaps indicates we are through the worst of the restructuring cycle. However, whilst the maturity wall continues to be chipped away by new bond and leveraged loan issuance, we still expect that a significant pool of the more highly leveraged borrowers will require formal restructuring to address their gearing issues.

Simon Boadle, head of the Debt Advisory team comments, “Overall the debt markets look set for a quiet summer and only by the end of Q3 will a clearer – and hopefully more positive – longer-term picture begin to emerge.”

For further info consult the Debt Markets Update – Summer 2010 from our UK colleagues

The final quarter of 2009 saw encouraging signs of confidence returning across a broad spectrum of bank lending. The mild softening in pricing and the lengthening of tenors in the corporate market, a cluster of new leveraged buyouts at the end of 2009 and the re-entry of banks into the commercial property market (on a selective basis) all presage a more active banking market in 2010.

Corporate lending – There are signs of increasing confidence in the corporate lending market reflecting a slight softening of pricing, particularly on larger deals and the extension of tenors to four years in some instances. Lenders are also more willing to consider financing a new borrower where there has been a resilient track record through the recession and prospects are attractive. There are initial signs that banks are beginning to consider taking material underwriting positions; a key milestone in the return to a more normalised market.

Leveraged finance – 2009 was the quietest year for over a decade in the syndicated leveraged finance market. However, there was an uptick in activity in the fourth quarter and the pipeline for new deals is encouraging. Whilst the market is not about to accept a surge in highly leveraged, thinly priced deals, a gradual improvement in lending conditions is realistic.

Corporate Bonds - For larger borrowers, the bond market filled the vacuum left by the contracting bank sector in 2009 with UK issuance up 12% year on year. Investor appetite also helped put pressure on bank pricing for large corporate refinancings. More borrowers could consider tapping the capital markets to diversify their lending sources (as well as lock in longer term debt).

Property finance - The sector has been one of the worst hit by the credit crunch. Lenders have generally been supportive of overleveraged credits where the borrower continues to service its debts, but take more robust positions where there is a new money requirement, in some cases taking material equity positions. There are an increasing number of lenders offering debt for new deals, but the level of available leverage will leave a significant funding gap on those deals with upcoming bullet maturities, which suggests there will be a significant amount of restructuring activity in the next 2-3 years.

Restructurings - The second half of 2009 saw a reduction in the number of borrowers commencing formal restructurings. However, there will continue to be a steady stream of borrowers seeking a renegotiation of their debt facilities over the medium term. Quite apart from the anaemic macroeconomic backdrop, companies that were the subject of leveraged buyouts in 2005-2007 face tightening covenant levels over the next 18 months.

Whilst credit markets have improved since the beginning of the year, borrowers continue to find raising or extending existing credit lines challenging. One of the big stories of the year has been the bond market.
Banks remain cautious and often reluctant to advance loans to new customers. However, during the third quarter, upward pricing pressure on bank lending has abated. Although we have yet to see significant falls in bank pricing, in the absence of further major economic shocks, the peak for pricing may now have passed.

Key findings of Q3-09 Debt Market Update:

Corporate Lending - a focus on existing customers but cautiously open for new business. 
Any new lending proposal will be heavily scrutinised and banks are reticent to refinance lending with others to avoid taking on their “problems”. A slight recovery in confidence could signal potential for a competitive tendering process for modestly-sized debt. We are seeing a strong strategic drive within some state-backed banks to increase their lending, albeit within more stringent credit quality parameters.

Leveraged Finance – difficult for the remainder of the year but innovative thinking means deals are possible.
The leveraged market will remain subdued for the remainder of the year, although there are pockets of activity at the smaller end of the market.

Corporate Bonds – an increase in activity and risk appetite.
In contrast to the banking market, the public bond market has seen a significant increase in activity this year. Investor risk appetite has also increased with an increasing proportion of BBB issuance. Corporates have been attracted to the bond market not only because it is an available source of credit but also because they have been able to secure longer tenors than on bank loans.

Convertible Bonds – a significant increase in issuance of this cheaper, more stable form of debt financing.
In recent months, there have been a number of household names issuing convertible debt. Convertibles have a cheaper cost of carry than conventional bonds because the implied value in the option to convert reduces the cash coupon. Companies with a stretched credit position may be able to issue convertible bonds when conventional debt markets are closed and in difficult credit markets the spread between standard cash coupon bonds and convertible bonds is likely to increase, making the latter more attractive.

Asset Based Lending - remains well positioned to capitalise on lack of credit from traditional sources.
Lenders have adopted a “back to basics” approach in recent months and are focusing more financing on physical assets and good quality receivables and less on cashflow-based facilities. Notwithstanding this the size of deals which asset based lenders are willing to finance has decreased in terms of individual hold levels.

Restructuring - expect a substantial re-pricing of facilities.
Even if lenders are only resetting covenants rather than rescheduling repayment profiles and/or maturities, companies can expect a substantial re-pricing. Most restructurings involve a negotiation between the existing lenders and shareholders thanks to the limited availability of credit from new providers and depressed M&A values. Whilst lenders are seeking to re-price facilities to what they perceive as heightened credit risk, they do not tend to pursue debt-for-equity swaps unless they are being asked to write down debt by the borrower or its shareholders. The amount of new money required and the jurisdiction of the borrower are also major determinants of the outcome of a restructuring.

For further details, read the Debt Markets Update  from our UK colleagues.