Questor Management Co.'s decision to use second-lien debt over the mezzanine market to finance its acquisition of Polar Corp. continued a trend this year that has seen second-lien issuance skyrocket. Questor chose to use the second-lien debt to buy Polar from Citigroup Venture Capital because it gives better pricing and the issuer doesn't have to give up equity, noted Garrett Kanehann, a v.p. with Questor.
"It's so attractive right now it's hard to find an institution that doesn't play there," he said. "It's really by and large replaced the mezz market." This past year $12.2 billion of second-lien debt has been issued compared to $3.3 billion in 2003, according to Standard & Poor's Leveraged Commentary & Data.
Banc of America Securities syndicated the second lien but Bank of America Business Capital is holding onto the first-lien debt. "They're going to hold onto the entire first lien facility because they love us so much," Kanehann said. The bank debt comprises an $88 million second-lien loan, a $12 million first-lien "A" loan and a $33 million revolver.
Relationship played a key part in selecting B of A as the lead. "Since our beginning at Questor we've had a relationship with the Fleet [Bank] guys," Kanehann said. "Out of the box I wanted to explore that and I had some confidence in their ability just based on how long we've known the guys." Questor worked with Mike Petik who reports to Ira Kreft, executive v.p. and group manager for the Midwest region of the Business Capital division.
"The proposals we got out of the box all included some sort of junior piece and the least junior of those pieces and to me the lowest risk piece that was priced attractively was the second-lien," Kanehann explained. "B of A is a leader in the issuance of this stuff and as a result it took some risk out of the execution for the sponsor. When you talk about working with an institution that eats this stuff for lunch at attractive pricing where I don't have to give up equity it's a pretty nice package," he said. The pricing of the credit is not disclosed.
Allan Allweiss, executive v.p. and central region marketing manager with B of A Business Capital, explained that the second-lien market has "moved from gapping on collateral, to providing an enterprise value alternative to lots of different products." Polar, which has annual revenues of around $230 million, and provides tank trailers services and parts was particularly suited to this type of financing. "In many transactions and especially for cyclical transitions, it's got a more tolerant credit perspective than subordinated debt and is an alternative to subordinated debt. Especially for Polar which is a cyclical industry," Allweiss said.
But one downside for Questor is that second-lien debt is floating rate. "In the event interest rates start spiking up you are going to pay more but we can fix that with some hedging," he noted. The company has not yet done any hedging but plans to. "We just don't want that much floating-rate debt for a company of this size," Kanehann added.
To date there have not been many defaults or restructurings with second-lien paper and once there is a credit correction many players may step out of the market. "We'll see pricing adjust a bit and see a number of players who have come into the market go away," Allweiss said. "Right now we're seeing a phenomenal amount of second lien execution. I think this is a product that does have legs. It will stay. It is a permanent part of the market."