Butcher Joseph Hayes Quarterly Financing Market Update
March 30, 2012
The truth regarding financing in today’s economic environment can be difficult to understand. If you are currently evaluating a refinancing or potential transaction, a fundamental question is whether or not financing is available to support your plans. This blog provides an overview of current market conditions and the outlook for 2012. In our discussion, we will provide an overview of the senior debt and subordinated debt markets and what you can expect with both as you go to market.
If you’re thinking about a liquidity event, the type and amount of financing must be appropriate to support both the distribution from the liquidity event (dividend recapitalization, leveraged ESOP, etc.) and leave enough debt capacity at the company level to support operations. For businesses with EBITDA of less than $5 million, this is even more critical as they typically have fewer financing options. If the business is fully leveraged with transaction debt, there is a greater likelihood that additional capital to support future operations will be harder to find.
With respect to senior debt, the markets have improved over the last 12 months. From an overall volume perspective, 2011 middle market loan volume of $182 billion was about equal to 2007 volume. With respect to pricing, the average spread over LIBOR on revolving lines of credit was 2.16% at the end of 2011, down .35% from the end of 2009 and .25% from year-end 2010. 74% of middle market revolving lines of credit were priced at LIBOR plus 2.50% or less at year-end 2011.
Senior term loan pricing has also decreased. At Q4 2011, term loan LIBOR floors and pricing averaged 1.38% and 5.33%, respectively. These levels compare to 2.19% and 5.44% at Q4 2009 and 1.70% and 5.22% at Q4 2010.
From a structural perspective, average middle market total leverage has increased from 2.17X TTM (trailing twelve month) EBITDA at the end of 2009 to 3.12X TTM EBITDA at the end of 2011. The average remaining life of a loan has increased to approximately 4 years as well. Middle market pure cash flow loans are still difficult to close, but more lenders are willing to close transactions that are not fully collateralized.
Subordinated Debt (Mezzanine Capital)
For companies needing capital in excess of what their bank can provide, the junior or subordinated debt market may be an option. Subordinated debt falls behind senior debt from a lien perspective and generally matures after the senior debt. It is usually structured with interest only payments until maturity and may carry additional incentives, such as warrants, to enhance the return for the subordinated lender to compensate them for their additional risk.
For middle market companies with EBITDA greater than $5-7 million, there is a fairly active subordinated debt market. Mezzanine financing is provided by business development companies, uni-tranche lenders (who provide senior and junior capital on a blended basis), dedicated mezzanine funds and merchant banking organizations. This market provides businesses with access to longer-term capital, with maturities of 5-7 years. The cost of funds is higher, with current interest payments of 10-12%, additional PIK interest (payment-in-kind interest; interest is added to the principal and compounded over the life of the facility) of approximately 3% and warrants that bring the overall cost to the mid-to-high teen level.
Subordinated debt usually provides a borrower with another 1-2X TTM EBITDA. For junior debt greater than 1.25X TTM EBITDA, all-in borrowing costs will range from the high teens to 20%. Please note that it is difficult to find subordinated debt for businesses with EBITDA less than $2-3 million.
Expectations for 2012 and Conclusions
Lenders expect to see a continued increase in activity in 2012. 96% of lenders surveyed by Thomson Reuters LPC see middle market loan volume remaining steady or increasing throughout the year.
Pricing should begin to stabilize as lenders see more stability in client performance. 70% of respondent banks expect LIBOR spreads to range between 3.00% and 5.00%, with over 70% also expecting to make loans without LIBOR floors in 2012. This is good news for borrowers as it eliminates one factor that can artificially increase borrowing costs. An additional 10-12% expect LIBOR floors between zero and 1.00%. Leverage expectations continue to stabilize and should improve slightly from a middle market perspective, with lenders expecting senior and total leverage of 3.0X and 4.0X, respectively.
So what does this all mean for you and your company? First, bank credit is more readily available and on more flexible terms than you might have seen over the past several years. Second, borrowing costs have declined and could decline further in 2012 as interest rate floors continue to go away. Finally, there are more readily available subordinated debt options for middle market businesses that may not have been as accessible in the past.
While individual circumstances will vary, the ability of middle market businesses to access required financing should continue to improve from both structure and pricing perspectives in 2012. If you would like to discuss the ability of your business to access additional capital or improve your existing capital structure, please contact the professionals of Butcher Joseph Hayes and we can provide you with our perspective on the options available to you.
Data Source: Thomas Reuters LPC