To be sure, the credit markets – engine to the U.S. buyout machine – remain healthy. Leverage multiples for mid-market buyouts have risen every year since 2009, when they bottomed out at 3.3x total leverage and 2.5x senior debt, according to numbers from S&P Capital IQ Leveraged Commentary and Data shown during a Jan. 22 webcast by Chicago investment bank Lincoln International. Total leverage multiples rose to 5.3x for all of last year, while senior debt multiples rose to 4.3x; new-issue first-lien yield to maturity in the middle market came in at 6.7 percent this month, well off a recent high of more than 14 percent in early 2009.
But zooming in on just last the few quarters finds the credit markets may have topped out. Total leverage multiples for mid-market buyouts fell from 5.7x (4.7x senior debt) in the second quarter of 2014 to 5.0x (4.1x senior debt) in the fourth quarter, according to S&P Capital IQ Leveraged Commentary and Data. Over roughly the same time, new-issue first-lien yield to maturity in the middle market rose from 5.8 percent to 6.7 percent.
Many lenders believe it’s a sign of tightening to come. According to a survey of more than 70 senior loan officers at banks, credit opportunity funds, business development companies and other mid-market lenders conducted this month by Lincoln International, just one in four respondents (24 percent) predict total leverage multiples will move higher in 2015, nearly a third (32 percent) predict they will move lower and 44 percent predict they will stay unchanged. By contrast, well over half (57 percent) of respondents in the predecessor survey predicted – correctly, it turned out – that total leverage would move higher in 2014.
Non-bank lenders, who have come to dominate the middle market, are more convinced than bank lenders that the credit markets will tighten, according to the survey. Some four in 10 (40 percent) non-bank lenders surveyed, for example, predict total leverage multiples will fall in 2015, compared to just 14 percent of bank lenders.
In a similar vein, many lenders surveyed also believe loan yields have bottomed out. Just 22 percent of respondents predict senior spreads will drop this year, while a third (33 percent) predict they will rise, and 44 percent predict they will remain unchanged. By contrast, nearly half of respondents (48 percent) in the predecessor survey predicted senior spreads would fall in 2014, which they did in the early part of the year.
Executives at Lincoln International painted a picture of a generally still-strong leveraged lending market during their “State of the Middle Market” webcast. Loan terms, for one, remain borrower-friendly. Said Managing Director Robert Horak: “What we saw in our transactions was that terms, such as scheduled amortization, covenants, the ability to make restricted payments, were all very favorable (for borrowers), and lenders were very hungry for deals throughout the year.”
Robert Brown, managing director and co-president North America, said the investment bank was coming off a record year for advising on M&A transactions, with no slowdown in sight. “Normally when we’ve had a record year, Q1 is very slow,” he said. “We’re not seeing that. We’re going to have … a record number of closings in Q1, and we see pitch activity … at a very high level.”
That said, the executives discussed a number of factors behind the tightening credit markets that could have staying power. Director Natalie Marjancik pointed to data showing that more than $40 billion last year flowed out of loan and high-yield bond funds. At the same time, some three-quarters of business development companies, a big force behind the unitranche lending boom, have effectively been sidelined from raising additional equity capital. That is because their stocks prices are trading at below book value, possibly due in part to their exposure to the oil and gas industry. BDCs play a big role in the middle market: altogether some 50 publicly traded BDCs have a combined portfolio valued at north of $60 billion, according to Keefe, Bruyette & Woods.
The upshot of trading below book value, said Marjancik, is that in coming months BDCs will likely be “more selective, their hold sizes might decrease, (and) you might expect higher pricing going forward in order to be enticed to make investments.” She added that some BDCs also might sell down parts of their portfolios in order to generate cash. Meantime, she said she wouldn’t be surprised to see a resurgence of senior cash flow, second-lien and mezzanine loans, which “in many ways have been off in the shadows of unitranche in the last couple of years.”
“There is liquidity,” summed up Managing Director Ron Kahn, but lenders are going to be more selective, lavishing liquidity on strong companies while leaving others to struggle. “It’s important that borrowers be realistic,” he said, “because not every deal today is going to get widely accepted in the market and get premium pricing and the highest leverage. There is going to be this bifurcation.”