Middle-market dealmakers are confident that the Aug. 24 stock market drop will not have an immediate effect on loans or M&A transactions.
The Dow was down about 588 points, or 3.58 percent, at the closing bell on Aug. 24 -- its worst day in four years. That came after a roller-coaster of a day, following an initial plunge of about 1,000 points at the opening bell. The volatility is driven by concerns over slowing global growth, especially in China, which recently devalued the yuan in an effort to increase consumer spending.
The dip “will not affect middle-market financing at all,” insists Theodore Koenig, CEO of Chicago-based lender Monroe Capital.
CIT Group Inc.’s (NYSE: CIT) Neil Wessan agrees. “Assuming that the market settles down this week, I do not see any concerns for middle-market loans or deals,” he says. Wessan is the group head for CIT Capital Markets. “There is ample liquidity in the market to absorb the current backlog of transactions.”
Although middle-market deals and loans may be impervious to a brief slump, dealmakers could find themselves affected if market volatility continues.
“I think that the loan market will have to get used to more broader-market volatility,” says Wessan. “Under Dodd Frank there has been a contraction of capital on the bank dealer’s desks, resulting in wider bid-offer spreads during periods of market movements up or down. In the current case with the market falling, the primary source of bids initially is from hedge funds, who may be more aggressive in their bids.”
The movements may persuade some owners that now is the time to sell.
“This added volatility may convince some owners of companies to sell in order to lock in their gains,” Wessan says. “Thus you may, over the long-term, have even more activity.”
Market volatility will also affect private equity firms taking out loans to execute transactions.
The dip could affect pricing on loans in the middle market, according to Lawrence Golub, CEO of middle-market lender Golub Capital, who says that stock market drops cause money to move from middle-market loan funds to broadly-syndicated loan funds, which in one to three months, could make middle-market loans more expensive.
“If broadly-syndicated loan secondary prices stay lower, we expect to see that over the balance of this year having an impact on middle-market pricing,” Golub says.
That could translate into a 25 to 50 basis point increase in first- and second-lien loan pricing, and total deal leverage going back down to 4x senior and 5.5x or 6x total, according to Golub.
For private equity firms, the shift installs the need for increased caution when agreeing to pricing flags on loans. “Smart private equity firms are putting a big premium on pricing certainty,” Golub says.