How Did Pricing Get Back to Pre-Crisis
Bubble Levels So Quickly?
The rebound in the junk bond market in 2009-2010
spurred the unprecedented liquidity and yield compression in the large buyout marketplace. The payout obligations of many large pension funds were built on the
assumption of 8% annual yield in perpetuity. The financial crisis and ensuing low interest rate environment
has forced a reevaluation of this expectation. Searching
for yield in 2009-2010, many pension funds turned to
the junk bond and leveraged loan marketplace.
Historically, asset-based lending has always led
the U.S. out of an economic downtown, followed by
cash-flow loans. However, due to the liquidity provided
by the junk bond market, cash-flow loans surged in
volume in 2010, much to the surprise of many industry
veterans. At the end of 2009, $404 billion of leveraged loans were set to come due between 2012 and
2014, according to the LCD team at Standard & Poor’s
Capital IQ. Many industry observers were predicting a
credit crunch. Now, the burden is under $150 billion
as firms have paid off debt and refinanced with bonds
or cash-flow loans.
The initial post-recession growth in asset-based
lending is typically triggered by several factors. First,
“collateral-good” deals are highly coveted because of
the downside protection. Secondly, recessions create
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many fallen angels, which asset-based lenders like —
“broken wing” companies with understandable and
fixable problems. Companies dying from 1,000 cuts
don’t typically survive recessions, although some will
argue that the low interest rate environment today has
allowed many companies’ managements to “kick the
can down the road.”
In the 2002-2003 economic recovery, asset-
based lending exploded overnight — from a situation
where nobody was lending much to anyone, deal flow
increased exponentially. Spreads on ABL credits swiftly
declined from LIBOR+5% to LIBOR+2% in many deals.
One ABL president at a major bank recently
expressed surprise at how quickly the market has
been willing to give up the pricing disciplines of 2008.
Today, pricing pressure is so intense that the occasional deal is getting done at LIBOR+ 1. With many
borrowers, LIBOR floors are ancient history.
The downward pressure on pricing is largely a function of the lack of new activity with borrowers that
substantially utilize their loan facilities. With utilization rates in the low 40%, asset-based lenders are
jumping on deals that offer good utilization. Borrowers
that offer good utilization are getting unitranche deals
done, which require less documentation.
One of the reasons that the volume and pricing of
dividend recaps have rebounded so quickly from the
financial crisis is that these loans offer significant
utilization. For example, one middle-market issuer,
NewWave Communications, recently closed a $134
million dividend recap deal that was sold to banks.
The deal included a $34 million revolving credit facility
and a $100 million term loan A priced at LIBOR+4%
with a 50 basis point front-end fee. The deal provided
a recapitalization, paid a dividend to shareholders and
repaid existing debt, some of which had been in the
form of an institutional term loan B. Had the issuer
gone out to institutional investors, it would have likely
paid a higher spread to execute a dividend deal.
Buyout financing can hold the promise of high utilization: 62% of debt was used in buyouts in 2011,
compared with 56% in 2010 in LBOs in the $250
million to $1 billion range, according to Pitchbook.
Total debt in deals is also increasing. According to
Pitchbook, total debt was 5. 29 times EBITDA in Q3/11
compared with 3.81 times EBITDA in 2009. The peak
of the market in 2007 was 6.07 times EBITDA.
Without enough paper to absorb the liquidity,
spreads on deals have been pushed down as banks,
which are swimming in deposits, vie for relationship
deals, ancillary business and increased market share.
The majority of deals in the past 12 months have been
refinancing, and typically the pricing goes down, not up.
The attractive spreads available to borrowers
from lenders (particularly regional commercial banks
with turf to protect) are causing some companies to
tap the bank market to refinance debt or raise new
money instead of opting for more expensive institutional tranches. In the current market, one of the big
takeaways is the spate of deals where borrowers are