Flush with cash and primed for buyouts, middle-market private equity firms are being offered loans with pricing and terms not seen since 1999. Spreads on upper middle-market loans--companies with $100-150 million in sales--have tightened 48 basis points from first quarter 2004 to first quarter 2005 and the average maximum debt-to-EBITDA ratio for companies with revenues of $100-500 million has increased from a low of 3.2 in the first quarter of 2002 to current levels of 4.85, which exceeds levels seen in 1998-2000, according to Goldman Sachs research.
Sponsored buyout volume is way up, stated Ian Larkin, a principal at American Capital, a publicly traded buyout and mezzanine fund with capital of $5.2 billion. But despite a mass of deals spread over 330 sponsors last year, there are not enough assets to meet the demand for either private-equity firms trying to buy companies or banks looking to lend to the space. This is leading to highly competitive auctions among the sponsors, but also great financing terms for the winners, which has some lenders concerned over lax underwriting.
On the lending side of the equation, commercial banks and middle-market specialty lenders are increasingly competing with investment banks, hedge funds and collateralized loan obligations. Sources pointed to firms such as Goldman Sachs Specialty Lending and Credit Suisse First Boston as being increasingly active in the middle-market space. In addition, institutional investors in search of spread in a flat yield curve environment are being offered "B" loans, while lenders such as Merrill Lynch and Dymas Capital are growing their businesses. Additionally, regional banks enjoying loss rates on loans that are at 15-year lows are looking to put cash to work for both relationship and investment reasons.
Still, other lenders and investors are optimistic that this aggressive lending environment will not lead to the pain experienced in the last downturn. "There has been a lot of money raised by private equity firms and those folks are looking to do deals in a competitive environment," said Buddy Gamina, a partner at private-equity firm Apax Partners. But he explained that the lenders are seeing the good strong cash flow on these deals and are being thoughtful about the types of companies they will stretch on.
Michael Young, a director in the syndication, trading and placement group of BNP Paribas, added that leverage may be rising but structural elements and covenants are staying strong. Furthermore, he believes the demand will continue. "I don't see any substantial pullback in the market until an event of some sort, such as default rates trending higher."
