GE Capital decision hurts mid-market shops

Middle market buyout professionals are feeling pinched because big lenders, such as GE Capital, have scaled back the issuing of new loans.

Summit Partners and The Gores Group have discussed launching internal senior lending funds, investors at the firms told a group of Pepperdine University alumni last week in Newport Beach, Calif. (The discussion was moderated by a PE Week writer).

“We talked about it at the firm level. Should we hire people and raise a fund within our core fund to finance great deals that can’t be financed right now?” said Craig Frances, a managing director of Summit Partners. “We decided we’re not senior lenders. That’s not what we do for a living, and we decided we weren’t just going to jump on the bandwagon and do it.”

Similarly, Scott Honour, a senior managing director of Gores, said that his firm had also discussed internally the idea of launching a debt fund to support its deals, but came to the same conclusion as Summit.

“That two firms have had this conversation internally means that others are, too, and someone will dive in,” Honour said.

There may be an appetite for such a move into debt lending, according to Honour. “One of our LPs told us they’d allocated $15 billion of new capital to go into debt origination,” he said. “There’s capital out there that is going to flow in and fill the void, but it’s going to take a little while to show up.”

Loans backing leveraged buyouts fell 61% to about $21.5 billion during the third quarter, according to data from Thomson Reuters (publisher of PE Week). The drop has put the breaks on deal making. The number of buyout deals dropped 24% last quarter and will likely close the year at half the number that firms racked up during 2007. Since 2005, the 10 biggest firms borrowed 9.5x their target companies’ annual earnings before interest, taxes, depreciation and amortization, according to data from Bloomberg.

Summit is currently investing from a $3 billion buyout fund that it raised in 2005. Gores raised $1.3 billion for its most recent buyout fund in 2007.

Although neither firm relies solely on leverage, debt is an important part of what they do. Frances said that Summit might typically have borrowed up to 6x a target company’s earnings to get a deal done last year. Now that multiple has fallen to 3x earnings. Honour said that Gores has gone from 2x earnings leverage to 100% equity in its transactions.

The main reason leverage ratios are falling is that GE Capital has shut its checkbook. “You had GE lending to a quarter of the middle market buyout deals,” Frances said. “We had a couple of deals we were working on with them where they said they weren’t doing any lending. It wasn’t a matter of multiples.”

Honour reiterated that message.

“We use GE a lot and they told us they were done for the year. When there’s that much dislocation, someone is going to step in.”