Leverage on large U.S. LBOs crept to 6:1 in 2017’s third quarter, the highest it’s been since the financial market meltdown of 2007, according to LCD.
That 6x number is of particular interest to the global leveraged finance market.
Federal regulators, in an effort to shore up the financial markets after the crisis, in 2013 issued guidance saying that loans with a debt/EBITA ratio in excess of 6x “raises concerns.” This prompted traditional corporate lenders – banks regulated by the Fed – to proceed cautiously regarding highly leveraged transactions. This cautiousness, in turn, has helped open up the direct lending/private credit market, where non-regulated asset managers increasingly are stepping in to provide often-riskier credits to leveraged borrowers.
A few items of note here: While non-regulated lenders continue to make inroads into the leveraged lending space, most of the deals underlying the above chart were led by traditional banks, demonstrating that those entities continue to drive this market.
Also, while overall leverage has indeed crept higher of late, other credit metrics point to a less ‘risky’ market in 2017 than in 2007, so 6.x leverage does not necessarily mean that risk is approaching unmanageable levels. (As well, a number of loan market participants continue to call the 6x target by the Fed ‘arbitrary’.)
LBOs, of course, are especially attractive to loan arrangers and investors as they generally feature higher fees and interest rates than non-M&A credits, such as those backing refinancings or general corporate purposes. The higher-yielding M&A deals comprised a relatively large share of leveraged loan activity in 2017’s third quarter, according to LCD. This is a marked change from the first half of the year, when repricing activity and other ‘opportunistic issuance’ dominated the U.S. loan space.
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