Lender Rebirth?
Investors are scouring the debt markets to figure out a place to play
April 9, 2009
With the credit markets practically closed for business private equity professionals, non-traditional lenders and junior lenders are taking matters into their own hands. It’s an anything-goes attitude that has yet to translate into any one mainstream trend other than an eclectic style in which fashion is dictated by need.
Similar to high school, in the debt markets it is the juniors who are always following the seniors. In this environment, however, the seniors aren’t doing much of anything, which has left the juniors room to improvise. Instead of waiting around for the banks to call the shots, many of the traditional junior lenders have stepped up their game. In March, for instance, Oaktree Capital Management filed to raise a $2 billion senior loan fund, while Sankaty Advisors, Bain Capital’s credit arm, set out to raise its own $200 million senior loan fund.
“If there’s more senior debt available there will be more opportunity to get deals done,” says Jeri Harman, founder of Avante Mezzanine, a new mezzanine lender, which is itself raising a $200 million fund to invest in the lower end of the middle market.
In addition to trying to move up the capital structure, some second lien lenders are taking a turn or a turn and a half of more debt to get a deal completed. "We are seeing more of that now," says Jim Hudak, co-head of corporate finance at CIT Group. "There are more junior players and equity players taking a piece of the sub debt.”
Hudak notes that a year ago, senior lenders were willing to lend at three times Ebitda, a multiple that has since shrunk to one and a half or two times. The equity and junior players have spotted an opportunity and are taking that turn of leverage and filling it in with sub debt.
“You can get a subordinated rate of return at what used to be considered senior debt risk,” Hudak cites. “For the right company, it's a good place to be in the capital structure. We are seeing many equity sponsors provide subordinated debt as opposed to raising new senior debt funds."
Other players are also picking up the slack. Anecdotally, some have even seen the regional banks enter the picture. Flush with TARP funding, many local players are putting money to work by completing asset-based deals with sponsors.
With asset-based lending the risk is shared and secured against hard assets, which makes the local banks more comfortable.
“Of course it has to be the right opportunity, but a lot of regional banks, such as TD Banknorth and Union Bank, are picking up the slack,” says Andy Steuerman, a senior managing director at Golub Capital.
Union Bank, for instance, backed EQT Infrastructure’s and Foristar’s deal to acquire Midland Cogeneration Venture with an asset-based loan. WestLB also lent on the deal for the gas-fired power generation company.
“We are seeing a lot of regional banks handling more asset-based lending,” Hudak concurs. “There's less credit risk and the structures are more solid.”
Of course, a popular strategy during tough times is the loan-to-own play. Players like Apollo Management, Cerberus Capital Management and Oaktree Capital Management have always found deals through the debt. In fact, Oaktree is currently in the market with a $5 billion loan-to-own fund; an enormous sum considering the narrow strategy.
The opportunities involve buying debt of distressed companies, and then swapping those positions for equity in the restructured entity.
Meanwhile, other firms have undertaken a similar tack as it relates to their own distressed portfolio companies. The Carlyle Group, Blackstone and Goldman have recently raised funds to take advantage of this strategy, while many middle market players say they are also looking into distressed debt, but view it more as a way to maintain a voice in a potential restructuring situation.
“Private equity is sitting on a lot of money but they are concentrating on their portfolios,” Hudak says. “They may buy some senior debt or sub debt, but most are not doing so with the stated purpose of taking control.”
He adds that if the investors are view it as a tool to fix the capital structures within their portfolios.
Although other unique lending strategies exist, there is also a reversion back to the traditional. With solid due diligence, a stable business, and a ton of equity, deals are still getting done the old fashioned way.
Wind Point Partners’ recent acquisition of Roskam carveout Hearthside might be one recent example. The company produces grain-based cereals and snack mixes.
It’s not a sexy deal by 2006 or 2007 standards, but it’s what dealmakers, and more importantly, lenders are looking for today. “This is a stable business, even in this economy,” Mark Burgett, a managing director at Wind Point, says. “It wasn’t an easy process to get the deal over the finish line, but the lenders liked that it was stable and diversified, with nice cash-flow characteristics.”
And remember those days of 20% or even 15% equity? They are nearly a distant memory, as sponsors are now putting between 60% and 80% equity into their deals, according to Hudak. And the rush has become more of a grind. “The equity sponsors are taking more time with the deals, which is leaving an extended time to perform even more due diligence,” he adds.
Although no one is expecting the lending market to come back in full swing, many lenders are cautiously optimistic that the market has at least found its floor.
“I believe it is possible that by the end of the year will have seen bottom and we may be feeling more comfortable lending,” says Harman.
Steuerman agrees. “We might have already seen the worst in terms of company financial performance. I think we will see the worst of it all in the next couple of quarters and then finally a bottoming out.”
(Homepage art provided by flickr.com user Ernst Moeksis via creative commons license.)
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