To see just how much of a game changer regulators’ crackdown on risky lending has been, take a look at a loan Vista Equity Partners arranged for one of its companies this year.
When the Austin-based private-equity firm shopped for a lender to arrange more than $200 million for tax-software firm Sovos Compliance, it passed on three banks, including one of the biggest underwriters of such debt, according to Kevin Sofield, Vista’s director of capital markets.
Instead, it opted to go with Golub Capital, a Chicago-based asset manager that charged a higher rate but allowed Vista to load the company with a level of debt that’s been deemed too risky by banking regulators. That meant Vista needed to put up less equity for Sovos to acquire another software company, Sofield said.
“Getting a greater quantum of debt is worth whatever that extra cost might be,” he said in a telephone interview.
Private-equity firms are increasingly turning to smaller lenders and asset managers to fund buyouts they’d normally have arranged by banks. That’s pushing more lending beyond the purview of regulators and disrupting the $822 billion market for leveraged loans that’s long been dominated by lenders including Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co.
Backing Away
Direct-lending funds, which raise money from institutional investors such as pension funds and insurance companies, surged to a record $29.9 billion worldwide last year, according to data provider Preqin.
Banks have been backing away from the riskiest deals as regulators demand higher levels of capital and discourage them from underwriting loans that would load a company with too much debt.
The Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. introduced guidelines in 2013 to curb excessive risk-taking in a market where total outstanding debt has ballooned more than six-fold since 2001, according to Standard & Poor’s Capital IQ Leveraged Commentary and Data.
Fed Report
The Fed on Wednesday noted that issuance of leveraged loans declined in the first half of 2015, compared with the level a year earlier.
“Market participants continue to point to the leveraged lending guidance as having affected the market,” according to the Federal Reserve Board’s Monetary Policy Report delivered to Congress. “The share of loans -- mostly those for middle-market companies -- originated by non-bank lenders reportedly has increased a bit further.”
The report said that the underwriting quality of leveraged loans had shown a “modest improvement, but overall, underwriting standards remain weak.”
The regulators have specifically raised concern over debt that pushes a company’s borrowings to more than six times its earnings before interest, taxes, depreciation and amortization. Sovos’s acquisition of ShipCompliant pushed the company’s leverage to seven times that measure, Sofield said. Golub shared the deal with Guggenheim Partners LLC.
‘Biggest Factor’
Golub wrapped up its best six-month period for lending since it entered the business 20 years ago, said David Golub, the firm’s president. It originated 58 financings in the first half of the year, with a total volume of $4.7 billion. About a quarter of the deals were for companies where the debt-to-earnings ratio was above the level recommended by regulators, he said.
“The growth in our originations in the first half was despite a relatively slow middle-market M&A environment,” Golub said. “The single-biggest factor is the leveraged-lending guidance.”
Some companies also are turning to smaller lenders because they are perceived as more nimble, said Greg Hackman, chief financial officer of retailer Boot Barn Holdings Inc. The company, which is 48 percent owned by Los Angeles-based private equity firm Freeman Spogli & Co., turned to Golub to fund its acquisition of Sheplers Inc. last month.
Jefferies, Guggenheim
“We considered a syndicated deal” through a Wall Street bank, Hackman said, but decided the process would be too lengthy. “In the end, Golub allowed us to be more competitive because we were able to get our financing in order very quickly.”
Other firms that aren’t beholden to the same regulations have benefited from the lending crackdown. They include Jefferies Group LLC and Guggenheim. Even private-equity firms including KKR & Co. have seized on the retreat by beefing up their lending operations.
JPMorgan, Bank of America, Credit Suisse Group AG, Deutsche Bank AG, Barclays Plc and Morgan Stanley are among banks that have passed on deals in the past year because they would have run afoul of the rules, people with knowledge of the situations have said.
“In years past you used to be able to invite three or four or five regulated banks into a financing process and be confident you could get 90 percent if not 100 percent hit rate on folks getting the approval for your deal,” Vista’s Sofield said. “Now with the regulatory guidelines, it becomes much less certain how many, if any, will be able to do it.”
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