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Direct Lenders Accelerate Into Middle- Market Senior Debt As Banks Fade

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Direct Lenders Accelerate Into Middle- Market Senior Debt As Banks Fade www.buyoutsnews.com March 9, 2015 NEWS ANALYSIS Direct lenders accelerate into middle- market senior debt as banks fade By Steve Gelsi hen Golub Capital CEO Lawrence Golub looked to add talent to grow his senior loan practice in the $250 million to $450 mil- lionW range last year, he didn’t have much trouble recruiting two dealmakers from big Wall Street banks. Golub Capital soon hired Hyun Chang and Michael Meagher as managing direc- tors to beef up its middle-market sponsor coverage. Chang formerly worked as an executive director at the financial spon- Hyun Chang, Lawrence Golub, Michael Meagher, sor group at J.P. Morgan Chase & Co and Managing Director CEO Managing Director Meagher worked as director in the finan- cial sponsors group of Deutsche Bank Securities Inc. in their deals. Senior debt often compris- In deals under $100 million, Madison “They were losing business to us and es 3x EBITDA on a total of 4x EBITDA in Capital Funding, a unit of New York Life, they were seeing the trends in the indus- total debt on a given buyout. Senior debt led the league tables with $787 million of try,” Golub said. “It’s good for us and good holders often have a first lien on all the senior loan business in 2014, followed by for them. They’re top dealmakers and this assets and stock of the company, expos- $666 million for General Electric Capital is the right place for them.” ing them to less risk compared to mez - Corp, and $189 million for RBS. All told, Golub Capital added about 40 zanine debt or second-lien debt. Senior To be sure, these league table mostly people in the past 12 months and may hire debt holders are typically first in line to reflect senior loans that have been syndi- 20 to 25 people this year, Golub said. get paid back in the event of a company cated to debt investors, and may not be Golub Capital’s hiring experience is bankruptcy. included if an LBO is financed through a hardly unusual in today’s market as direct Overall, favorable conditions remain structure that is not syndicated, according lenders, also known as non-bank com - in the senior loan market, with a healthy to a spokesman for Thomson Reuters LPC. mercial lenders, continue to grow their pace of mergers and acquisitions stoking (According to Golub Capital’s own rank- presence in middle-market senior loans debt deals. With hot competition for targets ing of senior loan lenders that includes its as big banks focus on larger deals of $400 and relatively cheap leverage, middle-mar- internal data, the company was No. 1 in million or more. It’s a macro trend that’s ket senior debt multiples climbed to 4.3x senior loan volume by number of deals in been picking up steam and is likely to EBITDA in 2014, up from 4x in 2013 and 2014, followed by Madison Capital Funding continue with the onset of new rules and 3.5x in 2012, according to S&P Capital IQ. and GE Capital.) capital requirements for banks both in Total leverage in middle-market deals rose Overall the business from the top the U.S. and Europe, according to industry to 5.4x EBITDA in 2014, the highest level senior loan providers grew significantly players. since 2007. in 2014. Among larger senior debt deals While corporations may use public Among larger senior deals for $500 mil- of $500 million or less, the top 20 book - equities, cash or bond debt to acquire a lion or less, Credit Suisse led the league runners rang up $27.4 billion in senior target, senior debt remains the biggest tables with $3.98 billion in book runner debt deals in 2014, up from $15.8 bil - piece of leverage deployed by buyout firms volume in 2014, followed by $3 billion for lion for the top 20 in 2013, according to General Electric Co and $1.9 billion for Thomson Reuters LPC. For senior debt Bank of America Merrill Lynch, according deals of less than $100 million, the top to Thomson Reuters LPC. 20 book runners tallied $3.7 billion of www.buyoutsnews.com March 9, 2015 | BUYOUTS NEWS ANALYSIS volume in 2014, up from $2.5 billion in “Nowadays, some of the larger non-bank loan market, echoed the sentiment of a 2013. institutions can take down sizeable pieces, sustained advantage for non-bank com- The interest rate debate and in some cases the entire credit facility, mercial bank lenders. with these products,” Khorana said. “There will continue to be a flight In terms of market conditions this One banker at a big Wall Street institu- toward the non-bank model because of the year, the view remains mostly upbeat, tion acknowledged it’s less appealing for enhanced flexibility it offers,” Bock said. but less optimistic than a year ago, banks to pursue senior debt deals of less “Banks will win the low-cost, plain-vanilla according to an annual lender survey than $400 million, and that more middle- loan all the time, but we don’t live in a by Lincoln International, an investment market deals of $150 million to $400 mil- plain-vanilla world.” bank that provides debt advisory servic - lion are going to non-bank competitors. es to middle-market firms. In its survey “Broadly defined, large institutions are Bullish fundraising for senior of nearly 100 lenders, Lincoln found 47 under a lot of financial and return pressure,” percent expect higher loan volume of all the banker said. “As a result, that’s meant debt funds types in 2015, compared to 64 percent in trying to do more business with less bankers Golub said non-bank lenders remind 2014, and 14 percent of lenders expect and trying to use capital with the highest him of commercial banks of the 1960s and lower loan volume, up from 8 percent in return when they use it. Naturally, that caus- 1970s, when big banks arranged loans for 2014. In addition, just 19 percent of lend- es the smaller deals to receive less focus.” middle-market companies and held them ers think senior loan leverage and pric - on their own books, rather than selling ing will move higher in 2015, a sharp Regs may provide pricing them off to investors via syndication. drop from 47 percent in 2014, the survey “All those players either transformed found. advantage themselves into investment banks or they Some of the less bullish sentiment Under the most recent interpretations went out of business,” Golub said. “Non-bank may reflect the closely watched plan by of federal banking guidelines, banks may lenders like us today — at least the ones who the U.S. Federal Reserve System’s Federal have to demonstrate that about 50 percent really are structured to be long-term lenders Open Market Committee to begin raising of a senior loan can be amortized within and solution providers — we’re the succes- interest rates this year. Any changes will five years, said Stefan Shaffer, managing sors of the regional bank that used to lend its reverberate throughout the LBO market. partner of SPP Capital Partners, a mid- own money to companies that made things.” “If interest rates rise, the cost of capi- dle-market investment bank that raises With LPs looking to find yield, direct lend- tal is higher, your fixed coverage charge senior debt. Banks have the leeway to ers have been raising capital for credit funds may be higher, and you may not be able do loans outside of this guideline, but it and business development company struc- to put as much leverage into a deal,” said could open them up to increased regula- tures. Oaktree Capital Group’s senior debt Ronald Kahn, managing director of Lincoln tory scrutiny. pool, Oaktree Enhanced Income Fund II LP, International. By contrast, non-bank commercial lend- drew in more than $2 billion last year. Any changes in interest rates won’t ers may require as little as 2.5 percent of “Fundraising is robust now because a affect the market dynamic favoring direct the principal in required amortization per number of leading players have proven it lenders for middle-market deals, however. year, giving them an actual cost advantage works, because we’ve demonstrated good Like Golub, Lincoln International plans on many senior debt loans. returns, and because investors have very to add staff this year after increasing its So while most commercial banks may few alternatives in the low interest rate ranks by 14 percent in 2014. offer lower interest rates, the cash cost of environment,” Golub said. “For companies with $15 million in paying back the loan may actually be high- Jeff Kopocis, principal at Altius Associates, EBITDA or less, alternative lenders are tak- er with the commercial banks because of a separate account and private equity advi- ing market share from traditional banks,” amortization requirements. sor, said he’s seeing more private credit Kahn said. “With increased regulations, Regulatory scrutiny isn’t expected to funds in the market today than six or 12 banks have become less interested in these ease any time soon. The LBO industry is months ago, partly because of LP interest, smaller credits, particularly for companies working off Federal Reserve guidelines along with long-term changes in rules gov- with limited collateral. However, alterna- originally published in March, 2013. This erning big banks. tive lenders, such as BDCs, are filling the past November, the Fed published a list “In terms of non-bank commercial lend- gap left by these banks.” of Frequently Asked Questions for highly ers, our view is the opportunity is still early Sunny Khorana, managing director and leveraged transactions (or HLTs) in a move and this isn’t something that’s a temporary head of sponsor coverage at Fifth Street seen as a warning shot to the industry dislocation,” Kopocis said.
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