By Leela Parker Deo
(Reuters) – The share of US institutional middle market loans that are classified as highly leveraged has hit a record high as strong investor demand continues to put pressure on midcap lending.
Excess investor demand is allowing private equity firms to produce aggressive borrower-friendly mid-market deals with similar terms to larger buyout loans, with lower spreads, looser documentation terms and less investor protection.
More than half of the middle market buyout deals sold to institutional loan buyers (53%) in 2018 so far have had leverage of 6.0 times or higher, according to Thomson Reuters LPC data.
In 2017, nearly 49% of deals had leverage greater than 6.0 times and in 2007, prior to the financial crisis, only 24% of deals had leverage above that level.
“Sponsors can access all the cheap debt and incremental capacity they could want,” a middle market lender said.
At least two deals booked in the second quarter had leverage of more than 7.0 times total debt-to-Ebitda.
E-commerce software provider CommerceHub raised US$335m in first-lien debt in May that boosted leverage to 8.6 times along with a US$145m privately-placed second-lien term loan, according to Moody’s Investors Service. The loan funded private equity sponsors GTCR LLC and Sycamore Partners Management US$1bn acquisition along with a US$623m equity contribution.
Secure access software provider Bomgar signed a US$360m acquisition financing that backed its sale to Francisco Partners in April with total debt to Ebitda of 7.8 times. The debt package included a US$25m revolver, a US$240m first-lien term loan and a US$95m privately-placed second-lien term loan.
Highly leveraged deals are usually reserved for upper mid-market companies which can access the institutional loan market. Nearly two-thirds of the borrowers in the data set are larger firms with more than US$50m in Ebitda.
Banks pulled back from underwriting highly leveraged loans after US leveraged lending guidance was implemented in 2013, which opened the door to a flood of cash from private debt and direct lending strategies targeting middle market debt.
The influx of capital and resulting competitive market conditions has allowed many US middle market companies to access similarly aggressive terms and conditions to larger borrowers with more liquid loans.
Midcap firms were previously less able to finance buyouts cheaply, pursue opportunistic repricings and secure greater financial flexibility by adding incremental debt than big companies as they were seen as more risky and illiquid credit investments.
Regulators appointed by the Trump administration are now taking a softer stance on bank regulatory oversight and banks are now wondering if they can get back in the game after ceding market share to alternative lenders.
Regional banks, which were also sidelined by LLG, are now evaluating whether the regulatory shift means that they can safely underwrite more aggressive deals.
“We are willing to entertain (leverage) over 7.0 times,” a regional banker said.
Comptroller of the Currency Joseph Otting said earlier this year that banks could underwrite deals outside the 6.0 times limit set in 2013, if pursued in a “safe and sound manner.” But although some banks are ready to move ahead, others remain mindful of the guidance.
“We are still underwriting to standards the regulators have put out,” a banker at another US regional bank said.
While regional banks are unlikely to offer the highest leverage, regulators’ more flexible application of LLG suggests that they may be able to take a more holistic view instead of looking at leverage as an absolute.
“It does open up opportunities to be selectively more aggressive. We can lean in, in spots,” a third banker said.