Senior lenders new to the market are beginning to make themselves felt in the sponsored LBO market. Several recent arrivals are now ramping up their loan programs to take advantage of the economic recovery.
In addition, the return of banks to leveraged finance in the second half of 2010 promises more liquidity in the market, stronger competition for sponsor business, and potentially lower loan rates with greater leverage.
Lenders provided $21.9 billion of financing for North American sponsor-backed deals in the fourth quarter, just shy of the record $24.1 billion set in the second quarter of 2007 at the peak of the mid-decade boom, according to Thomson Reuters LPC. The $53 billion issuance for the year as a whole was four times the volume of 2009. But that doesn’t begin to tell the story, because of the depressed condition of the market as the economy struggled to emerge from the Great Recession.
In some ways, setting out in the midst of the crash gave the newcomers an advantage, in the sense that they were not struggling with a portfolio full of problem credits.
Consider the case of NXT Capital LLC, a mid-market commercial finance company based in Chicago that launched in May with the backing of Greenwich, Conn.-based
By the end of the year, the firm had closed on 35 transactions and had attracted two follow-on funding rounds, including a $150 million equity commitment by
“We had a very successful startup year,” said Robert Radway, NXT’s chairman and CEO, who led a group of former principals from Merrill Lynch Capital to start the new firm.
Or consider Fifth Third Sponsor Leveraged Finance, an arm of Cincinnati banking company Fifth Third Bancorp that launched in October 2009 headed by two managing directors: Brian Crabb, a veteran of Heller Financial, GE Capital, and most recently, CapitalSource Finance; and, Josh VanManen, a long-time Fifth Third executive who had been in the bank’s structured finance business.
Fifth Third Sponsor Leveraged Finance helped finance a dozen debt deals last year, expanding into a bigger market by lending to sponsors buying companies with $10 million to $75 million in annual EBITDA; the regional bank’s existing sponsor business had focused on portfolio companies with $4 million to $10 million of EBITDA, Crabb told Buyouts. “Fifth Third overall has taken a lot of share over the last couple of years.”
One advantage was arriving in the market at a time when many lenders had frozen solid because of the credit crisis. Amalgamated Bank, a privately owned New York bank that works largely with union members, founded Amalgamated Capital in September 2009 with a mandate to seek out and finance LBOs in the lower middle market, which Timothy Clifford, the head of Amalgamated Capital, described as companies with enterprise value less than $100 million, revenue of $15 million to $100 million, and EBITDA of $3 million to $15 million.
“There was no national player servicing the lower end of the middle market,” said Clifford, who formerly was a managing director and principal at Churchill Financial and head of the firm’s Boston office.
Over the course of the next 15 months, Clifford and his team criss-crossed the country, trying to contact the 500 to 600 firms that made the kind of deals his group was seeking to finance. And it worked: The firm has reviewed 700 opportunities from 240 different sponsors. It has deployed only $150 million to 10 portfolio companies, but Clifford said that also was part of the plan.
Amalgamated Capital is quite disciplined on extending credit, Clifford said. “We say no a lot more than we say yes, but when we say no, we provide a very thoughtful response to our clients.”
At the same time, the firm stressed the stability of its funding, which comes from the deposit base of the bank—and which was a way for Amalgamated Bank to diversify away from a heavy reliance on real estate lending, Clifford said. “When we say yes, it’s a firm yes,” Clifford said. “Just because you have a lender give you a commitment, that doesn’t mean they’re going to be there at the close.”
Too, a judiciously scaled ramp-up seemed the most appropriate strategy for the bank, which is heavily regulated, Clifford said. “The regulators are not necessarily fond of the asset class.”
Return Of Big Banks
For all their youthful bravado, however, these newcomers scarcely made a tremor in the sponsor-finance league tables (see table at right).
That list was dominated in 2010 by General Electric Capital Corp., which was bookrunner for 114 U.S. middle-market deals worth $8.4 billion, according to Thomson Reuters LPC. That gave GE Capital an 18 percent market share. The only competitor to come close was the previous four years’ champ, Bank of America Merrill Lynch, the bookrunner on 64 deals worth $6.0 billion last year, good for 13 percent market share. (Fifth Third was the only one of these newcomers to crack the list, as bookrunner on 12 deals worth $423.4 million and 1 percent market share.)
GE Antares Capital, the specialty mid-market lending unit of GE Capital, closed more than 70 transactions in the fourth quarter in the sponsor finance area, said John G. Martin, the president and chief executive officer at Chicago-based GE Antares.
But big commercial banks have returned to the sponsor-finance arena, especially in the second half of last year, Martin said.
“Commercial banks are still very aggressive in the middle market and upper middle market,” he said, mentioning B of A, Wells Fargo & Co., JPMorgan Chase & Co., Credit Suisse and Goldman Sachs Group Inc. “Six months ago they were coming off the sidelines and I would say they are fully in play.”
After ending 2010 with a flurry of activity, January began with a lull, but lenders expect activity this year to match or exceed last year’s issuance.
“A lot of institutions and a lot of private equity firms are taking a deep breath after a race to the finish line in 2010,” said Martin, noting that some transactions were probably pulled into the fourth quarter as a result of tax-related selling pressure, with the pending expiration of Bush administration tax cuts on capital gains. (The lame duck Congress extended current tax rates for two more years.)
Going into the new year, the lenders and Thomson Reuters LPC seem in consensus on loan pricing: 450 to 500 basis points above LIBOR, with a LIBOR floor of 150 bps, depending of course on the condition of the company and its industry. Senior lenders are typically willing to provide 3.5x to 4x leverage on EBITDA, with mezzanine or other subordinated debt providing another 1x to 1.5x leverage. Sponsors are typically putting up 40 percent equity stakes, less on higher quality or larger deals, more on hairier or smaller ones.
With the return of more competitors, syndications are once again gaining popularity among lenders, allowing them to participate in more deals and reducing their risk on any single credit. Leonard M. Tannenbaum, the chairman and chief executive officer at Fifth Street Finance Corp., an $800 million business development company in White Plains, N.Y., said some sponsors have been emboldened to believe they can put together their own syndicates, rather than choosing a syndicate partner and let them do the deal.
He cited one pending deal for a company he did not name, a $150 million revenue target with EBITDA around $20 million, backed by a sophisticated sponsor investing out of its fifth fund.
“We offered them all the money to fund the facility. They had enough interest from different parties that they tried to cobble it together themselves,” Tannenbaum said. “I think it’s ending up about where we had originally proposed.”
Despite the greater availability of credit, lenders seem to be keeping their heads on leverage. Even deals that have large oversubscriptions are still drawing only 3.75x multiples on their senior debt, said Crabb of Fifth Third. “The market has anchored at a rational leverage level. I think what you will see in 2011 is you’ll probably see pricing compress.”
And while loan issuance may not return to the peak levels of the mid-decade boom years, “It probably rebounds to a higher level. To my mind, private equity is a mature, durable asset class,” Crabb said. “Private equity buyers by definition can’t hold assets forever.”
According to Thomson Reuters LPC, some $65 billion of sponsored loans will come due during the next two years.