1 Maranon Capital recently put out a report predicting a $185 billion shortfall in senior debt for buyouts by 2015. Isn’t that a lot of money?
I’m not sure we feel comfortable being quoted there is a $185 billion gap in the senior market for fear of being pushed onto the lunatic fringe. But as we look at the market, we think there is a dramatic lack of senior debt capital, particularly in the lower mid-market.
There are three key reasons: One is the consolidation of the leading cash flow lenders. Two is the uncertain path of CLOs and where they are going. And three, no real competitive entry of any scale that fills the gap left by the consolidation and those that have fallen by the wayside.
There are new competitors, but when you add them all up, they barely put a dent in the capital needed.
2 I’ve heard it said this is a bifurcated market between large-cap and the mid-market, especially the lower mid-market. Is that your view?
I wouldn’t call it a bifurcated market. I would say it’s at least a four-flavor parfait.
3 Like our recent cover story.
Right. Below $10 million in EBITDA cash flow lending, if a single regional bank or lender can take the credit and hold it, we’ve experienced that market to be selectively extremely competitive. Spreads may be narrower than they should be and senior leverage may be higher than we think it should be. Often these deals are taking place without mezzanine in the capital structure.
For deals between $10 million to $25 million in EBITDA, you need two to five lenders to make that work, and a single mezzanine lender. Spreads there are probably widest, origination fees are probably highest. This is the segment most prone to being short of capital going forward.
Above $25 million in EBITDA, the market splits into two distinct categories. There is the unrated credit, where liquidity and investor interest is reasonably strong, pricing is lower than 10-25 and leverage is higher, and there is rated credit, which is very aggressive and thinly priced.
4 I hear regional banks are being pressed by their regulators to go the asset-backed route, rather than lending on cash flow.
Episodically you see a regional bank taking an aggressive stand. But their regulators are pressing them on capital, they continue to focus on portfolio and credit quality, and their risk appetite for leveraged credit is measured, given their capital base. They will play, but they will have a limited impact.
5 When does this come to a head?
CLOs are going away quickly. Their reinvestment periods are expiring. M&A activity in the mid-market is as busy or as it’s ever been. Demand for leveraged finance is very strong. We think it comes to a head beginning in 2011 and continues until 2014. The terms and conditions for mid-market senior loans will induce investors who are not historically capital providers, because the terms will be so favorable.