By Jonathan Schwarzberg and Leela Parker Deo
(Reuters) - Alternative lenders are expected to take a larger share of leveraged lending from banks in the next two years as the non-bank lenders step in to help refinance the first wall of revolving debt to come due since updated leveraged lending guidance was implemented in 2013.
Regulatory guidelines aimed at curbing banks’ risky lending, a rising interest rate environment and the possibility the economy could dip into recession, as well as a fresh dose of uncertainty following Britain’s vote to leave the EU, suggest some junk-rated US borrowers could have a hard time renegotiating $122 billion of debt tied to revolving credit facilities from banks that mature in 2017 and 2018.
Banks have been the usual source of funding for revolving credits lines, but with heightened regulatory oversight aimed at curbing banks' lending to junk-rated companies, issuers with high leverage may need to tap non-traditional sources.
Though alternative debt capital providers such as the credit arms of private equity firms, hedge funds and other investment vehicles do not have the balance sheet size or scale to compete with the likes of banks like JP Morgan or Bank of America Merrill Lynch (NYSE:BAC), alternative lenders willing to increase their capacity to underwrite revolving credit facilities will have the biggest advantage when it comes to earning market share.
While it is ultimately the term loan business, and associated fees, that alternative lenders are after, it is the shorter-dated revolvers that come due first that are likely to prompt a borrower to initially seek refinancing options. At some price the access to capital offered by non-banks, at more flexible terms with less restrictive covenants, is a deal borrowers will be willing to cut. Herein lies the opportunity for alternative lenders.
“It’s a package deal,” said Richard Farley, chair of the leveraged finance group at Kramer Levin Naftalis & Frankel LLP. “The revolver gets you a seat at the table.”
US companies have US$106bn of term debt maturing in 2018, but when looking at credit facilities due that year that include revolvers the tally jumps to US$187bn, according to data from Moody’s Investors Service.
Issuers with loans that might be criticized under the leveraged lending guidelines designed to curb high leverage levels might have an especially hard time accessing capital.
“The deleveraging or the retrenchment of the banks has created some gaps in the financing markets,” said a market participant. “What we’ve seen is other forms of capital are stepping in and filling in those voids…. It’s not displacing the banks, it is complementing the banks.”
Revolvers act as giant corporate credit cards, providing issuers with access to working capital. Though like a credit card they aren’t always utilized, lenders still need to maintain enough available capital to cover the possibility of full utilization.
Revolving credits have traditionally been primarily offered by banks at low rates in order to benefit from the ancillary business—fixed income, equity issuance, cash management, for instance—that the lending relationship with a specific company might bring in the future.
TRICKLING IN
Alternative lenders have already stepped in to provide debt financing on new deals that would likely have come under regulatory scrutiny if arranged by banks due to high leverage levels. Earlier this month investment banks passed on underwriting Thoma Bravo’s US$3bn buyout of data analytics firm Qlik Technologies. The private equity sponsor turned instead to a group of alternative lenders and opted for a unitranche loan, a structure that combines senior and subordinated debt into one instrument.
A group led by Ares Capital with joint arrangers Golub Capital, TPG’s credit specialist TSSP and Varagon Capital Partners backed the buyout with a $1.075 billion unitranche facility. As part of the transaction, the alternative lenders agreed to provide a US$75m revolving credit facility.
At least one issuer is currently tapping the alternative lending market to refinance a criticized loan. Terms of the transaction have not been released.
Now with a fairly steep refinancing cliff on the horizon, alternative lenders see a real market opportunity to take additional market share, especially when there are issuers with leverage well above the 6.0 times level that the federal regulators are scrutinizing.
“The bet is that more companies are going to be downgraded and SNC criticized, not less,” said Farley.
The Shared National Credit (SNC) review is a biannual examination of bank loan underwriting standards.
On a closer horizon, US$42bn of term loan debt alone is set to mature next year. The number almost doubles to US$83bn when accounting for expiring revolvers, providing ample opportunity for the alternative lenders.
“Anyone who has a criticized loan is going to be very focused on the revolver and revolver extension,” said the first source. “And if there’s an opportunity to refinance the entire structure, then we are going to look at those so we can package the revolver with the other things that are well-liked.”