By Andrew Berlin
NEW YORK (LPC) - Regulated banks are underwriting more highly leveraged buyout loans for US companies as the Republican administration relaxes guidelines aimed at reducing risk, which is leveling the playing field with unregulated lenders again.
Banks overseen by the Federal Reserve (Fed) and the Office of the Comptroller of the Currency (OCC) are pitching debt packages with leverage of 7.5 times and 7.75 times, respectively, on the auctions for roofing distributor SRS Distribution and education software company Renaissance Learning, several leveraged finance bankers said.
These levels are far higher than the six times leverage limit adopted by regulators in 2013 to curb risky lending. To comply with the guidelines, credits also had to be able to repay all senior debt or half of total debt within five to seven years from free cash flow.
Leverage levels on buyout financing led by regulated banks have averaged 5.5 times since 3Q17, according to Thomson Reuters LPC data.
“For good assets, regulated banks are doing whatever they want,” a senior leveraged finance banker said.
Constraints imposed by the leveraged lending guidance paved the way for nonregulated banks and lenders such as Jefferies, Nomura, Macquarie and KKR Capital Markets to pick up the slack and grab market share as regulated peers stepped back.
Buyout financing led by non-regulated lenders has carried leverage of 6.98 times on average since the third quarter of 2017, the data shows.
Regulated banks are currently capitalizing on the opportunity to win back lost ground as the political environment continues to undermine enforcement, sources said.
Investors appear to be willing to lend to more highly leveraged buyouts, particularly credits that they know and like, such as SRS, which has been through two buyouts already.
“ (SRS) has been LBO’d twice before. Both were homeruns for private equity guys and debt investors. The deal has been a race to the bottom in terms of leverage, pricing and terms,” a senior leveraged finance banker said.
“Renaissance is a good business, the pay down works, and we like the space,” another senior leveraged finance banker said.
LAISSEZ FAIRE
The OCC, alongside the Fed and the Federal Deposit Insurance Corporation (FDIC), in 2013 updated guidance on leveraged lending to improve underwriting standards and banks’ risk management framework.
Exceeding the six times leverage limit previously allowed regulators to censure banks and even impose penalty fees if the ratios could not be reasonably justified. Credit Suisse (SIX:CSGN) was famously singled out in 2014.
“Back in the day, creditworthiness didn’t matter,” a senior coverage banker said. “You’d pick when to go above 6.5 times, but no way would you go above 7.0 times.”
The Trump administration is taking a more lenient approach. The Government Accountability Office (GAO), the investigative arm of the US Congress, said in October that leveraged lending guidance is subject to Congressional review, which means that it could be overturned.
In February, Comptroller of the Currency Joseph Otting said that he supports banks transgressing guidelines as long as they have enough capital and it does not impair their safety and soundness. President Donald Trump is continuing to nominate new business-friendly policy makers to fill vacancies on the Board of Governors of the Federal Reserve.
The rise in leverage offered by regulated banks could drive leverage provided by non-regulated banks and lenders even higher in response, bankers said.
“It seems difficult at these kinds of levels but if the demand for new paper continues to be there, it could happen,” a syndicate head said.
PUSHING HIGHER
Financing for the buyouts of food contract manufacturer Hearthside Food Solutions and packaging machinery company ProMach, and the merger of education technology firms PowerSchool and PeopleAdmin also highlight the trend.
The buyout of Hearthside Food Solutions by private equity firms Charlesbank Capital Partners and Partners Group has leverage of 7.0 times, sources said. The financing will be led by Goldman Sachs (NYSE:GS) and Barclays (LON:BARC), which ran the sale process and provided staple financing.
Staple leverage was increased from around 6.5 times during the process so the banks would remain competitive, the sources noted. Regulated banks offered leverage above 7.0 times, but the new owners opted for a more conservative debt profile.
Private equity firm Leonard Green & Partners’ buyout of ProMach was backed by a 7.3 times-levered debt package, underwritten by Morgan Stanley (NYSE:MS) and Goldman Sachs, sources said. The transaction closed in March.
Financing for the tie-up of Vista Equity Partners-backed education technology companies PowerSchool and PeopleAdmin has a debt-to-Ebitda ratio of around 7.5 times, sources said. It will be led by Barclays and Credit Suisse, they said. Private equity firm Onex Corporation is investing and will be an equal equity owner in the combined company.
The apparent willingness to extend credit beyond recent norms is also a function of investor demand. Regulated banks are not offering higher leverage indiscriminately, sources said.
“It’s situation specific, and depends on valuation and margins,” a leveraged finance head said.
Barclays and Goldman Sachs declined to comment. Credit Suisse, Morgan Stanley, SRS sponsor Berkshire Partners and Renaissance Learning sponsor Hellman & Friedman did not respond to requests for comment.