Leverage levels for buyouts are close to pre-credit crisis levels as banks are more willing to underwrite highly leveraged deals following the Office of the Comptroller of the Currency’s softened stance towards lending risk.
So far during the second quarter, leverage for U.S. buyouts averages 6.57 times, the highest level since it reached 6.65 times during the third quarter of 2014. Leverage at this level had not been seen before that since 2007, before the credit crisis hit when leverage on buyouts topped out at 6.8 times on average, according to Thomson Reuters LPC data.
Leverage, a measure of a company’s debt versus its earnings before interest and tax, was inching higher this year but took off after the Comptroller of the Currency Joseph Otting indicated in February that banks could underwrite deals that fell outside the constraints of the Leveraged Lending Guidance implemented in 2013.
The guidelines called for a close look at deals with more than 6.0 times leverage and required issuers to be able to pay down all senior debt or half of total debt within five to seven years.
Otting reinforced his remarks last week and said banks may take on some deals that fell outside the guidelines if they do so in a “safe and sound manner” and have the capital to support that activity.
“I think underwriters are willing to take a little more risk,” said a senior banker. “The market is certainly accommodating.”
Another contributing factor to rising levels is the presence of several technology companies entering the market with buyout loans, market sources said. Both underwriters and investors are often willing to give tech names a bit more leverage than other sectors because of the strong, predictable cash flows.
Among those companies, educational technology platform PowerSchool has launched US$1.3 billion of loans, while a very successful highly leveraged deal from educational software company Renaissance Learning priced on May 21.
PowerSchool’s deal will be leveraged around 7.5 times, as reported by Reuters. U.S. private equity owner Vista Equity Partners is merging the issuer with a talent management software company company in its portfolio called PeopleAdmin along with an investment by Canadian private equity firm Onex Corp.
Renaissance Learning saw strong enough demand to price a US$730 million first-lien term loan at 325bp over Libor, on the tight end of 325bp to 350bp guidance, and a US$310 million second-lien term loan at 700bp over Libor, also on the tight end of guidance. This deal was leveraged at 7.75 times per Reuters.
Another big buyout in the tech sector expected to have leverage substantially higher than 6.0 times is the acquisition of software company BMC by U.S. private equity firm KKR, announced this week.
Issuers have had the upper hand when it comes to lining up loans this year as money has poured into retail loan funds, collateralized loan obligations (CLOs) have been booming and investors from foreign countries have scurried for floating rate assets in the United States.
“You’ve had interest from just about every place you can,” said an institutional loan buyer.
On the back of this interest, 68 percent of leveraged buyouts were leveraged above 6.0 times during the first quarter, the highest level on record. During 2017, this number was 64.2 percent, which was also higher than even 2007 when 61.5 percent of buyouts had leverage of more than 6.0 times.
The market is still trying to catch up on deals with leverage north of 7.0 times though. During 2007, 38.5 percent of deals had leverage greater than 7.0 times, a number that has never been reached again. The first quarter of 2018 saw 29 percent of buyouts with leverage above 7.0 times.
Bankers say despite the comments from Otting and a desire from investors for more deals that underwriters will be hesitant to allow leverage to increase to those levels again.
“As a whole, it does feel like leverage has crept up a bit,” another banker said. “Without a doubt, from our perspective, we have not altered our thinking in terms of leveraged lending guidelines. Everything that we approve continues to be what we think is going to have a pass rating.”
(Reporting by Jonathan Schwarzberg; Editing by Michelle Sierra and Chris Mangham; Additional reporting by Lynn Adler)