Are middle market senior lenders really back?
Newspapers and industry publications say they are. You hear of certain private equity funds that claim they’ve been accessing senior debt. You may even get calls from some lending officers offering their wares.
Yet for all the hoopla that senior lending has returned, we believe that senior debt for middle market companies (defined as those with EBITDA less than $50.0 million) is still limited and only available to the best credits. Yes, there is an ample supply of asset based senior debt. Obtaining senior debt based upon collateral values is now easier than it has been in several years and some asset based lenders are even starting to offer overadvances, something unheard of even six months ago.
But the good old fashion senior cash flow product, the engine behind the vast majority of buyouts before the current meltdown, is still a fraction of what it use to be. We’ve seen some statistics from S&P LCD which suggests that the number of active lenders has declined from approximately 154 in 2007 to just 18 today. While we think this may be a little too harsh, we see a significant decrease in active lenders and, those that remain, have very tight screens for accepting new deals.
For starters, almost every cash flow lender has new rules that require their borrowers to have a minimum of $10.0 million in EBITDA, and often want minimums of $15.0 million and higher. We can debate all day long whether companies below this minimum earnings level ever had the critical mass to qualify for cash flow lending. However, companies that often did obtain cash flow debt can no longer do so. In addition, lenders are focused on providing cash flow loans only to financial sponsors making it extremely difficult for family owned and entrepreneurial companies to obtain cash flow senior debt.
And for those private equity portfolio companies that are large enough to access the cash flow markets, capital is still restrictive and only available to those transactions where (a) the borrower has demonstrated outstanding fundamentals and consistent earnings, particularly throughout the dark days of the recession; (b) have a compelling capital structure that does not overleverge the company, provides adequate fixed charge coverage, and has a meaningful amount of equity; and (c) a financial sponsor known for supporting their transactions. Deals that are lacking any one of these criteria can find their need for cash flow senior debt going unfulfilled.
Further, companies that are seeking new cash flow senior debt to take out an existing creditor are also finding tough going. Prospective lenders continue to ask – what does the incumbent know that I don’t? Am I just inheriting someone else’s problems?
And even if you do find that you meet all the criteria, hold sizes continue to remain anemic so putting together even a $75.0 million senior debt financing, often requires 5 or 6 different lenders. Have you ever tried to get six lenders on a conference call at the same time, no less agreeing on every term and condition in a credit agreement!! It’s like herding cats and the result is that borrowers get saddled with the lowest common denominator.
But all is not lost and help is on the way. In my next column, we’ll talk about the hottest new products on the market – unitranche and second lien debt.
Ronald A. Kahn helps buyout firms secure debt for acquisitions and related transactions. Reach him at firstname.lastname@example.org