In many cases, providers of credit alternatives are unable to reduce interest rates because of the demand for yield from their own investors, market watchers say. For instance, investors in publicly traded business development companies are looking for returns of 8 percent to 9 percent, meaning the BDCs cannot reduce their lending rates much below 11 percent to 13 percent, said Ronald Kahn, a managing director at Chicago investment bank Lincoln International LLC and head of its credit advisory service. “Yields cannot go below an arbitrary floor, but leverage multiples can go up.”
Use of subordinated debt is actually on the rise, market watchers report. Midway into the second quarter, sponsors were taking more junior debt while reducing senior leverage, according to sister service Thomson Reuters Loan Pricing Corp., with mid-market leverage multiples jumping to 3.4x senior debt to EBITDA and 4.7x total debt, compared to 3.7x by 4.1x total in the first quarter. This widened sub debt’s contribution to 1.3x EBITDA from 0.4x. LPC defines the mid-market as companies with total loan deal and revenue size of $500 million or less.
The trend continues a pattern seen over the past year. Standard & Poor’s Leveraged Commentary and Data reported that sub debt contributed 0.7x EBITDA in the first quarter, compared to 0.2x a year earlier. LCD defines the mid-market as companies with less than $50 million of EBITDA.
But wider leverage multiples increase credit risk, and with dealflow still thin, the quality of the credit can also strongly affect not only the price, but also the ability to get a financing completed. Not only in the more illiquid, lend-to-hold mid-market, but also in the more broadly syndicated loan and high-yield bond markets, creditors remain cautious, welcoming growth stories while rejecting more doubtful credits.
“Better quality businesses still find a way to attract strong interest and garner attractive yields for their business,” said Michael Chirillo, a senior managing director at GE Antares Capital. “Lesser quality companies will struggle.”
Among the more successful is TricorBraun Inc., a portfolio company of CHS Capital, the Chicago-based buyout shop that formerly did business as Code Hennessy & Simmons LLC. GE Antares, a unit of GE Capital, led the financing of a $555 million credit facility, in this case all senior secured, for TricorBraun, a maker of packaging from bottles and sprayers to pails and drums.
The package included a $75 million senior revolving credit facility and a $480 million term loan, and not only refinanced outstanding debt but also made distributions via dividends and stock repurchases. Chirillo said the deal, which included 55 investors in the facility, was 2x oversubscribed.
As a result, TricorBraun was able to win more borrower-friendly terms; the deal, which was talked initlally at Libor+425-450 basis points with a 1 percent discount, priced ultimately at L+425 and a discount of 50bp; final returns also offered TricorBraun a stepdown to L+400 based on performance, Chrillo said. He said he could not discuss terms of the dividends or stock repurchases. Sister service Thomson Reuters LPC said the deal priced at 4.2x senior and 5.6x total debt to EBITDA.
GE Antares has had a longstanding relationship with CHS Capital, and with TricorBraun through a series of sponsor relationships dating to the 1990s, when it was a much smaller enterprise. Although GE Antares has a hold size up to $70 million or so, it was able to work with UBS as joint lead arranger to line up nearly $1 billion of commitments to back this loan, Chirillo said. “This is a great example of our ability to grow with our borrowers and address their ongoing financing needs.”
Another successful venturer into the market was CAMP Systems, which was oversubscribed for its planned $345 million loan to finance its handoff to GTCR from Warburg Pincus. LPC described the initial offer’s structure, a covenant-lite facility at 5x senior by 7.5x total debt to EBITDA, as “extremely aggressive.” Investors said the highly recurring business model helped warrant the lofty leverage levels.
CAMP Systems, a developer of aircraft maintenance technology, cleared the loan at L+525 with a 1.25 percent Libor floor, rather than the wider early talk of L+550. With a step-down, the loan’s spread drops to L+500 when first-lien net leverage is below 4x EBITDA. The facility also included a $115 million, 7.5-year second-lien term loan. A $30 million, five-year revolver rounds out the covenant-lite deal, LPC reported. Deutsche Bank was lead left, joined by Credit Suisse, RBC and UBS.
Other prospective borrowers have fared less well. In May, Harland Clarke Holdings officially postponed its planned offering, a $298 million prospective bond deal that had been earmarked to pay down an outstanding term loan, LPC reported. Harland Clarke, backed by Ronald Perelman’s M&F Worldwide Corp., had planned to tap the market for additional notes to pay down $280 million of its extended term loans, leaving it with $692.8 million of extended term loans, offered at L+525 with no Libor floor, and $729 million of non-extended term loans priced at L+250.
Harland has struggled for acceptance in the capital markets. In April, the company won lender approval to extend at least $1 billion of its existing term loan to June 2017 from June 2014 in a transaction that anticipated 30 percent paydown of the extended loan, using proceeds of a $300 million note offering, LPC reported. In May 2011, the company withdrew a proposed amend and extend agreement on its loans due to lack of demand. Harland’s prospects may be dimmed by the markets it serves: It is one of the nation’s two dominant check printers and is a vendor of financial technology, mostly to community banks.
The result is a lot of debt financing available for a limited number of transactions, said Andrew Hettinger, a managing director at Boston-based Crystal Financial, a specialty finance company. “There are a lot of inquiries, but not a lot of deals.”
Crystal Financial focuses on out-of-favor industries and companies, such as retail, building products, heavy industries and media such as newspapers. Such industries are pricing their debt at 4x senior by 6x total debt to EBITDA, compared to 7x or 8x total leverage for more popular market segments, Hettinger said.
While the company prefers not to offer mezzanine itself—“you don’t want to be way out there on a junior basis” with riskier credits, he said, emphasizing that he was speaking generally, not about a specific deal—the company not infrequently finds itself behind a senior asset-based revolving loan backed by the issuer’s inventory with Crystal Financial, offering a unitranche issue of senior secured financing, sometimes asset-backed with a first lien on all assets except inventory.
That unitranche often has Crystal Financial in a first-in, last-out position with a mezz lender. The company’s part of it would be Libor plus 500 basis points, up to 2x EBITDA, while the mezz portion would be in the 13 percent to 14 percent range, he said. “There’s usually one or two BDCs that will say, ’I can do the mezz, but why don’t you leave the ABL in place and let us do the senior?’”
Competition is keen, but Crystal Financial is winning its share of deals, Hettinger said. “Our deal flow is pretty good this year.”
Indeed, unitranche and other flavors of subordinated debt appear to be permanently changing the structure of buyout deals, said Kahn of Lincoln International. “Unitranche has continued to take market share from the structure, leaving a lot of mezz guys scratching their heads figuring which way to go.”
At the same time, mezzanine managers crowd the market along with other fund sponsors. The latest fundraising tally by Buyouts (see table at right) shows 39 sponsors in the market raising mezzanine funds with an aggregate target of $19.9 billion. A year ago, the comparable tally showed 29 sponsors in the market to raise $15.6 billion.
The widening transaction multiples mean that senior, unitranche and subdebt lenders are all competing harder, said Theodore L. Koenig, the president and chief executive officer of Chicago specialty finance company Monroe Capital LLC. He pointed especially to the rise of BDCs, which have benefited from low interest rates following the financial crisis.
These BDCs have seized on market volatility to gain market share, although their progress has been uneven. As of the end of 2011, St. Louis-based investment bank Stifel Nicolaus & Co. was tracking about 25 existing BDCs, plus an estimated 18 more in registration, as Buyouts previously reported. BDCs historically invested primarily in mezzanine and other forms of junior capital, though they have diversified in recent years into other parts of the asset stack.
“BDCs have capital to deploy and they need to deploy that capital,” said Koenig, whose company had a BDC, Monroe Capital Corp., in registration but withdrew its application in April. “Sponsors are taking advantage of that influx of junior capital in the market.”