Article

A Leveraged Lending Overview from a Lender's Perspective Part 1

Posted by Nicole Coffey on Jan 05, 2016 06:00:00 AM

Topic: ALL

Woman meeting with lenders

Over the last few years we continue to see growth in the leveraged lending market both in the U.S. and in Europe. In fact during 2013 and 2014 the leveraged lending market was either in line or above the levels we recognized during 2006 and 2007. Standard & Poors has compiled data to reflect the leveraged loan volume in the United States from 2003 to 2014. As illustrated in the enclosed table, leveraged loan volume was approximately $528 billion in 2014 and $600 billion in 2013, respectively, compared to about $535 billion and $490 billion in 2007 and 2006, respectively.

The growth over the last few years has been fueled by excess liquidity in the market. Senior debt is accounting for a majority of the middle-market financing, with senior leverage averaging 4x against a 4.6x total multiple, according to Forbes. This compares to a more challenging market in May 2010, where senior lenders were extending just 3x leverage, on average, against a multiple of 3.6x.

Additionally mezzanine players are encountering heavy competition from banks due to the surplus of liquidity as banks are underwriting senior stretch once again. In fact, lenders say mezzanine spreads have fallen to below 14% all-in, primarily due to the heightened competition, leaving little room for write-offs or principal loss. This is similar to the levels seen in 2007. However prior to the senior lending boom in 2006-2007, mezzanine rates hovered closer to 18-20% all-in. Whether this growth will continue and return to pre-recession levels is still unknown, but what is known is that there is increased sensitivity on the leveraged loan market today versus eight to nine years ago. This is something that affects all parties including buyers, sellers, equity sponsors, and lenders.

As mentioned earlier, in 2006-2007 the deal level was up and the market was hungry which led to many deals getting done in a very aggressive manner. This basically meant covenant-lite, minimal reporting, and overall loosely structured deals. At that time it became common for deals to be structured with very long amortizations and often without the ability to de-lever in a realistic timeframe. This aggressiveness assisted in the financial crisis we faced not too long ago and unfortunately appears to be occurring again as seen in the chart below. However, guidance has been provided by regulators to specifically identify appropriate leverage levels and appropriate timeframes for which the borrower needs to de-lever and as a result closely monitors banks.

 When anyone hears the word ‘guidance’ immediately one may quickly jump to negative conclusions as to how this is going to impact the overall M&A market coupled with how is this going to impact the ability to get leveraged loans approved. But before anyone does that, it’s important to think through the rationale behind this ‘guidance’ and at the same time fully understand the hot points with regulators, which will be the same for your lender. Understanding this upfront will assist in minimizing any surprises down the line and at the same time allow you to properly structure a solid deal at the onset of a new opportunity. This is something everyone can appreciate especially when it comes to advising clients on how to successfully borrow funds.

Continue reading about Leveraged Lending in Part 2.