Leveraged Loans: Middle Market Leverage Eases, Though Cov-Lites Gain

Apr 2 2014, 11:02am CDT | by

Leveraged Loans: Middle Market Leverage Eases, Though Cov-Lites Gain
Photo Credit: Forbes Business

Middle-market leverage has softened over the past six months, in a reversal of the trend that saw top-heavy multiples spill over large-caps last fall.

Total leverage stands at 4.7x, on average, down from 4.9x at Sept. 30, 2013, when the middle market eclipsed large-cap deals (4.7x) for the first time ever, according to S&P Capital IQ LCD. The current large-cap average has climbed to 4.9x.

The reversal can be seen in LBO financing as well. Middle-market LBO debt has dropped to 4.9x total, from 5.3x last fall, which then tied large-cap LBOs for the first time. Leverage on today’s large LBOs has risen to 5.6x.

While middle-market leverage appears to have been “right-sized” behind the broader market, it would be misleading to suggest that tone has cooled. It hasn’t. Liquidity is flush. Regulatory pressure on banks is shifting business to the shadow banking community, where new entrants are starting to pile up. Competition for mandates is fierce, especially amid a lack of LBO activity.

In fact, some of today’s terms are more aggressive than before the credit crisis. About 55% of total middle-market volume this quarter was leveraged at 5x or greater, up from 41% last year and 47% in 2007.

In recent months, covenant-lite has found more success downmarket than previously. Roughly $450 million of institutional volume this quarter, or 23%, has been covenant-lite. During the past two years, the share has lingered in the 8-10% range.

Middle-market LBOs – which have failed to gain traction – stand at 4.9x total, the highest level since the credit crisis. The sample here is only five deep, but the upward trend shows itself year over year. In 2013, 41% of middle-market LBOs were leveraged at 5x or greater, up from 24% in 2012.

Equity contributions are eroding as well. Equity checks are 39% of the capital structure for first-quarter LBOs. That’s down from an average of 46% in 2013 and 41% in 2012. In the overheated days of 2007, contributions were 32%.

Note: For this analysis, LCD defines “middle market” as companies that generate $50 million of EBITDA or less.

Source: Forbes Business


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