FALL 2013
Although the first half of 2013 was marred by stagnant activity within the middle market lending environment, senior lenders across the middle market seem quite optimistic about finishing the year with a bang. While it is difficult for senior lenders to pinpoint the exact cause for their optimism, the recurring talking point has been that these senior lenders are unequivocally committed to lending once again. That has yet to be seen, and so far this year there has been little evidence of this commitment; however, there was a clear uptick in lending activity during the latter part of this summer, and to add even more weight to their claims, the end of every calendar year tends to bring with it an increase in overall lending activity. Therefore, middle market borrowers are hopeful that these senior lenders will (quite literally) put their money where their mouth is. Senior lenders have continued to aggressively court borrowers with good credit and strong collateral, and these borrowers have been fortunate enough to obtain senior loans at historically low pricing. In fact, the competition for these strong borrowers has caused some senior lenders to revert back to pre-2008 levels not only with respect to pricing, but also with respect to higher leverage ratios and relaxed covenant packages. Unfortunately for a number of middle market companies, particularly those who are not deemed to have "good credit and strong collateral", obtaining credit from senior lenders has continued to be challenging. The good news is that middle market companies continue to exhibit a fundamental improvement in their respective operating performances. This positive performance, coupled with low default levels across the middle market, hopefully gives middle market borrowers the same level of optimism as middle market lenders.
Similar to the trend set by the senior lending market, the latter half of this summer provided a slight uptick in activity within the mezzanine lending market. In fact, the trend over the last two years clearly evidences a rise in mezzanine fundraising levels. Couple this trend with a significant amount of SBA leverage available to middle market borrowers, and there is suddenly a potential for a meaningful amount of junior capital to flow to the middle market. Mezzanine lenders have continued to increase staffing and capital-raising activities for some time now. And similar to the senior lending market, mezzanine activity tends to increase towards the end of every calendar year. To date, mezzanine lenders have focused their lending activity towards the higher end of the middle market; however, middle market borrowers are hopeful that mezzanine capital will soon be deployed in the heart of the middle market over the last quarter of 2013.
Private equity players accumulated significant amounts of capital throughout 2012 and have taken advantage of investment opportunities requiring disproportionately high amounts of equity. This accumulation of capital led to healthy deal volume for private equity firms throughout 2012, and although deal volume tapered off during the first half of 2012, there is healthy optimism that the upward trend from 2012 will continue, albeit gradually. Private equity can now safely be considered a viable option for middle market companies requiring capital in excess of that which is available in the senior and mezzanine debt markets. To date, private equity activity has been focused on companies at the higher end of the middle market. Over time, and possibly even during the last quarter of 2013, we believe we will see increased private equity activity in the heart of the middle market.
Based on an informal survey of senior lenders, mezzanine lenders and private equity firms, the following is a summary of deal terms in today's market for financially strong middle-market privately held businesses:
Senior Debt
Leverage Ratio:
- Loan amounts for well-capitalized companies are in the range of 2.5 to 3.0 times trailing 12-months EBITDA for companies with less than $15 million EBITDA, but there are noticeable exceptions in the 3.0 to 3.5 times trailing 12-months EBITDA range (the trend has continued its upward trajectory throughout 2012 and into 2013).
- Loan amounts are in the 3.0 to 4.0 times trailing 12-months EBITDA range for companies with more than $15 million EBITDA (consistent with 2012).
Interest Rates:
- 30-day LIBOR plus 1.75% to 2.50%, or Prime Rate plus 0.25% to 1.00%, for revolving debt with full collateral coverage (with more senior lenders competing for good quality borrowers and in some cases offering interest rates at pre-2008 levels);
- 30-day LIBOR plus 1.75% to 2.50%, or Prime Rate plus 0.25% to 1.00% for 3-5 year term debt (with more senior lenders competing for good quality borrowers and in some cases offering interest rates at pre-2008 levels);
Advance Rates:
- 80% to 85% of Accounts Receivable (with senior lenders more willing to provide higher advance rates to borrowers with less than 5% A/R dilution);
- 50% to 70% of Inventory (depending on the nature of the Inventory), based on either a forced liquidation valuation or net orderly liquidation valuation (net orderly liquidation valuation is significantly higher than forced liquidation value and has now returned as the more typical benchmark). The advance rate on Inventory is often lower for smaller companies, in part because senior lenders choose not to incur the expense of a third party Inventory appraisal.
Fees:
- 0.00% to 1.0% of loan amount (senior lenders are beginning to waive all fees; however, they continue to charge fees or expect other forms of reimbursement for loans secured by fixed assets or real property due to appraisal costs and other expenses incurred by senior lenders);
- Unused line fee of 0.125% to .50% for revolving debt with a term greater than 364 days (consistent with past practices), although many senior lenders are using 0.25% as their benchmark.
- Bank service fees and covenant waiver fees are still applicable; however the cost of such fees has decreased from 2011, depending on the nature of the bank service and/or covenant waiver.
Mezzanine Debt
Pre-September 2008, it was common place for senior lenders to provide financing in excess of collateral value (otherwise known as "cash flow loans"). In 2009, cash flow loans became the exception and were usually supported by personal guaranties from one or more stakeholders with substantial net worth. Throughout 2010 and 2011, cash flow loans began to reappear for borrowers with very good credit, although interest rates for such cash flow loans were typically at the higher end of the LIBOR rates stated above. Throughout 2012 and 2013, senior lenders have become more aggressive with cash flow loans, at least with respect to companies with more than $10 million EBITDA. The principal amounts of such cash flow loans are typically not more than 1.0 to 2.0 times trailing 12-months EBITDA, with no more than 3-5 year terms. We anticipate this upward trend will continue, albeit only for borrowers with very good credit.
Leverage Ratio:
- Loan amount, including senior debt, not to exceed 4.0 to 5.0 times trailing 12-months EBITDA (slight increase from 2011; consistent with 2012), depending on the quality of the borrower and the amount of senior debt.
Interest Rate:
- 12% to 14% with 10% to 12% current pay and 1% to 3% paid in kind, for companies with less than $15 million EBITDA (noticeable decrease from 2012); and
- 11% to 13%, with 11% to 12% current pay and 1% and 2% paid in kind, for companies with more than $15 million EBITDA (noticeable decrease from 2012)
Fees:
- 1.0% to 3.0% of loan amount (consistent with 2012).
Warrants:
- Warrant coverage to provide mezzanine lender with an all-in IRR of 12% to 18% (consistent with 2012).
Equity Financing
IRR:
- 20% to 30% IRR (consistent with past practices).
Valuation:
- 4.5 to 8.5 times trailing 12-months EBITDA, with signification variation based on company size, industry and growth trajectory.
Debt to Equity Ratio:
- 35-50% equity/50-65% debt (up from historic lows of 20% equity/80% debt pre-2008, but down from 50% or more of equity in 2008/2009).