Leveraged finance review: North America's demanding problem

Capital abounds for private equity deals of all sizes in North America, but new M&A has yet to take off

Private equity fund managers have been keeping the investment banks busy so far in 2013 – though not as busy as most bankers would like.

Bank of America Merrill Lynch generated the most activity in North America during the first four months of the year, financing 98 private equity-related transactions worth a combined $12.1 billion and claiming 7.4 percent of the market. Not far behind, however, were rivals JPMorgan and Credit Suisse, at 7.2 percent and 7.1 percent respectively. Barclays, Deutsche Bank and Goldman Sachs each accounted for more than 5 percent of the lending market.

While leveraged finance is enjoying a renaissance of sorts thanks to a renewed level of confidence in the debt markets, new merger and acquisition activity was fairly muted during the first four months of the year, save for two proposed mega-deals: Silver Lake’s $24 billion take-private bid for PC manufacturer Dell – which included a reported $15 million debt load – and Berkshire Hathaway’s acquisition of Heinz for $28 billion alongside Brazilian investment firm 3G Capital, both agreed in February (although at press time the former was far from a done deal, thanks to Carl Icahn). 

Not including these two transactions, North American buyouts totalled just $11.8 billion between 1 January and 30 April, compared to $17.6 billion during the same period in 2012, according to Dealogic.


Much of the lending activity in 2013 to date has involved private equity firms completing refinancings and recapitalisations rather than new acquisitions, according to Harold Bogle, managing director and global head of Credit Suisse’s financial sponsor coverage.

“They’re refinancing to reduce the costs of borrowings or high-yield in almost every portfolio company where they can,” Bogle says. “Sponsors are monetising a great many portfolio companies, or at least portions of them.”
Though buyout activity is down, the appetite for lending seems to have increased.
Credit Suisse has managed to play a role in many of 2013’s biggest transactions, including Silver Lake’s bid for Dell and 3G’s acquisition of Heinz.

“Compared to other years [since the financial crisis], I think that the markets will allow much bigger transactions – anywhere from $10 billion to $15 billion certainly looks achievable,” Bogle says.

One of the reasons for this is the search for yield by investors, who are looking for better returns from the high-yield and leveraged loan market than they can achieve from (for example) government debt.

“Investors are re-allocating assets to those spaces through the formation of new CLOs and through high-yield inflows, [and] that has enabled there to be a fair amount of demand that created the liquidity to do those big deals,” Bogle says.

In addition to Heinz and Dell, Credit Suisse has also provided financing for Apollo’s $410 million bid for bankrupt Twinkies-maker Hostess Brands, Carlyle’s $666 million take-private of bank and valuation specialists Duff & Phelps, and Bain’s buyout of software company BMC alongside Golden Gate Capital, a $6.9 billion deal agreed in May.

“A very favourable set of market conditions have persisted in the first quarter and through April into May,” Bogle says. “Overall our activity is pretty comparable to last year on a year-to-date basis.”

One by-product of these favourable conditions, however, is that GPs have been using less equity in their deals. “We’ve seen some transactions a lot closer to 20 percent equity and there were times around the crisis and after when it was 33 percent-plus,” Bogle says.

While some regulators may have turned a blind eye to the increasing use of leverage during the boom years, the trend is being followed more closely this time around.

In late March, the Federal Reserve, Federal Deposit Insurance Corporation and the office of the Comptroller of the Currency released a revised version of their guidelines on leveraged loans, outlining what regulators consider safe leveraged lending activities, including underwriting standards and how banks monitor the financial health of borrowers.
In a joint statement, the agencies said that “while there was a pull-back in leveraged lending during the crisis, volumes have since increased while prudent underwriting has deteriorated”. 
US leverage levels rose from “an average multiple of 4.9 times EBITDA…to 5.7 times between the second and third quarters of [2012]”, according to a Bain & Company report.
“Regulators want to do whatever they can to prevent the type of aggressive lending that was common during the boom period,” says one New York-based M&A lawyer.


While the availability of leverage has not always been consistent in the upper and lower ends of the market, the North American mid-market has also benefited from a strong lending environment in 2013.

 “Across the marketplace, you’re seeing increased availability of leverage,” a senior North American banker recently told PEI’s sister magazine Private Debt Investor.

Unfortunately, mid-market private equity firms have also generated less buyout activity year-to-date.
“The entire industry is pretty meaningfully down on the new M&A side,” says John Martin, chief executive of GE Antares Capital. “My sincere hope is that M&A activity starts to pick up.”
As a result, GE is also trying to make up for the lack of new M&A by doing refinancings and recapitalisations.“If I [could have my way] I’d be doing more M&A volume,” Martin says. “It works either way; it just honestly works better if it’s M&A activity.”

One of the most robust sectors in North America this year, both for limited partners committing to funds and general partners hunting for deals, has been energy. “The energy space is definitely a spot where we’ve seen a pretty meaningful pickup in activity,” Martin says. 

Software companies have also generated more activity recently compared with recent years, according to Martin. “I would attribute that to some extent to the fact that you have software concepts that have grown up and developed to a point where they are more consistent cash flow generators now,” he says. “So whereas [software companies] may have been almost by necessity financed largely with equity prior to this point, they’ve [now] created P&Ls that can support a debt facility.”


While banks remain the first port of call for private equity firms needing to finance acquisitions, the lending ecosystem has developed in recent years to incorporate a wide variety of institutional investors.

“The whole world of alternative lenders is increasingly important as the current regulatory regime has narrowed the fairway for banks,” says Jim Hunt, chief executive officer and chief investment officer of THL Credit, the debt investing arm of Thomas H Lee Partners. “An investor like us can provide two or three different ways to address the same credit opportunity. It really lets us help the bank find the right attachment point for them.

Rather than competing with banks for deals, Hunt sees business development companies like THL’s and others as having a “symbiotic” and “synergistic” relationship with banks.

Despite the somewhat disappointing M&A market during the early months of 2013, Hunt believes the third and fourth quarter of the year will see a spike in deal volume.

“Based on the indications I’ve heard from mid-market investment banks, they’re expecting a busy second half of the year for capital deployment,” he says. 

Lenders of all stripes will be hoping he’s right.