May/June 2011

FinalCut: Booming Debt Market Largely Unavailable to ‘Turnarounds’

A report issued by Morgan Joseph TriArtisan noted that although the current syndicated loan and high-yield debt markets are booming, they remain largely unavailable for “turnaround” situations and lower middle-market borrowers seeking to raise funds.



FinalCut_MidMarket

Managing director and head of Morgan Joseph’s financial restructuring group James Decker, noted, “No question that some borrowers are feeling left behind in the current market.” Decker said, “Focused more on enterprise value, call protection and reporting requirements, the syndicated and high-yield markets may under appreciate a more mature business with strong asset value and cash flow for deleveraging. The result can be purgatory for these borrowers: saved from peril by effective management during an unprecedented recession, but now are not a proper fit to access headline leverage in the wider capital markets.”

Decker added that this situation makes it “more imperative than ever for borrowers without a straight forward refinancing option in the syndicated markets to be proactive in exploring all their options, including a potential refinancing in the private non-rated club loan market.”

The report also noted the appearance of “new” credit funds focused on direct lending, many of which were originally raised with all equity, but were still able to generate handsome returns by picking off dislocated secondary paper in 2009. As the secondary market quickly recovered, however, most funds have since transferred their strategies to direct lending, building books with debt returns they hope to leverage and create equity returns for investors, the report pointed out.

As the senior markets have become more competitive, there has been an increased willingness on the part of banks and senior lenders to lend against these loan books. “While not at the sub-100 spreads once available to funds during the CLO boom, the leverage has allowed direct lending funds to further reduce pricing and yield requirements,” observed Decker. “The result has been an opening of the ‘club’ market for smaller middle-market, turnaround and/or storied credits.”

The report also noted that continued competitiveness in the asset-based loan market, resulting in an ongoing downward trend in average pricing as well as loosening structures in the fourth quarter. Average rates on ABL facilities have dropped “an astounding” 125 bps during 2010.

The syndicated loan market is “currently every investors’ darling.” Both yields and structure have eased, with clearing yields back to the 6% range seen in the spring of 2010, but with the average leverage now approaching 4.5x versus the sub-4.0x levels of last year. Covenants are lightening up and higher volumes of second liens and PIK toggles could be right around the corner.