US Mid-Market Lenders Worried About Leverage, Lending Documents: Report
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NEW YORK (Reuters) – Lenders to midsize U.S. companies are increasingly concerned about higher debt levels of mid-market companies compared to a year ago, as well as what they consider as less restrictive leveraged loan documents, according to a survey by Carl Marks Advisors found.
Higher debt levels and borrower-friendly loan arrangements, a result of very competitive market conditions last year that prompted lenders to make such concessions, could impact loan portfolios if performance marketing is under pressure.
Carl Marks Advisors, a mid-market focused corporate restructuring and investment bank, conducted a nationwide online survey in December 2017 with 190 participants in areas related to US mid-market lending, including bank lenders traditional, alternative lenders, legal and accounting advisers, restructuring advisers, private equity and hedge fund investors, and other financial and business consultants.
“This is now the third longest economic expansion in US history, so it’s been around a bit for a long time. Businesses don’t necessarily improve and there is a lot of capital – both debt and equity – to seek too few deals, ”said Patrick Flynn, managing director of Carl Marks Advisors, in an interview. before the publication of the survey. “But while there are relatively more worries today than a year ago, it’s not necessarily a predictor that the next contraction will be closer.”
The survey found that 76% of those polled are more concerned than they were at the start of 2017 about the debt levels of mid-market U.S. companies.
“In 2017, a lot of deals added debt, but there wasn’t a lot of value creation,” said Joseph D’Angelo, partner at Carl Marks Advisors. “There aren’t many unencumbered assets left to borrow more money. If a business fails to do this, it is likely to experience restructuring. “
The leverage on institutional middle market transactions increased in 2017 to 5.51 times the total debt on EBITDA from 4.95 times in 2016, according to data from Thomson Reuters LPC. EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of a company’s operational performance.
Regarding the concessions lenders have offered to borrowers and private equity sponsors in the face of aggressive market conditions, 48% of respondents said they viewed loan documents executed in 2017 as less restrictive for borrowers than those issued in 2017. executed immediately prior to the 2007-2008 financial crisis. . Thirty-five percent said they did not consider the documents to be less restrictive, while 17% said they were unsure.
Mid-market covenant-lite issuance reached an all-time high of US $ 25 billion in 2017, according to LPC data. For comparison, before the financial crisis, the middle market covenant-lite volume in 2007 was US $ 7.49 billion.
“The credit market is functioning fully and the pressure to deploy capital remains strong. It is difficult to predict what will trigger the pendulum to return to terms favorable to lenders. Currently, it seems the reluctance of lenders is always resolved with price and terms, ”Flynn said.
BULK DOCUMENTS
Loan document concessions resulting in light loans or spring clauses with lower triggers are the main concern of respondents in 2018, followed by the possibility of adding additions to the EBITDA calculations.
Covenant-lite refers to loans that are stripped of certain lender protections, including financial maintenance tests requiring the borrower to meet monthly or quarterly performance standards. Such tests serve as warning signs in a potential default scenario. Raising EBITDA, on the other hand, can increase a company’s financial flexibility when it comes to incurring additional debt or fixing limited payments, thereby increasing credit risk and weakening investor protection. .
“As long as there are so many different sources of funding and they continue to raise capital, there is no force that would influence the loan documents to tighten,” D’Angelo said.
Investor demand for exposure to mid-market lending strategies fueled a record US $ 69 billion fundraising in 2017, surpassing the US $ 60 billion set aside in 2016, according to LPC data.
When it comes to the types of lenders that are expected to face the biggest challenges in their loan portfolios this year, 26% of respondents said mezzanine lenders are at the top of the list. Business Development Corporations (BDCs) came next with 23%, 18% said troubled investors and 14% selected traditional banks. Specialty finance companies and direct lenders were tied at 6.84% each, while bank asset lenders and equipment finance companies ranked least likely to have problems, at less than 5% each. .
“Many BDCs are investing in much smaller companies, which may be more vulnerable to economic contraction. BDCs also have a higher cost of capital than regulated banks, which means looking to invest in places that justify their cost of capital, which can also translate into additional risk, ”said Flynn.
Despite increased concerns about leverage and loan documentation, respondents were particularly divided over technical and payment defaults in 2018. Forty-three percent said defaults would increase and the same proportion said that they would stay the same this year.
“We don’t really expect much of a difference in 2018. If the economy can continue to grow, we expect to see more industry specific situations. The changes continue to impact health care with downward pressure on federal and state budgets, ”D’Angelo said. “The freezing cold has given the energy sector a boost. With the increase in prices, there is more confidence around the table to make more constructive deals. We might even see mergers and acquisitions there.
Reporting by Leela Parker Deo; Editing by Lynn Adler and Jon Methven
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