The below summary from SPP Capital Partners can be viewed in full here: http://sppcapital.com
Market Tone
Coming off a record-breaking year in 2018, the private capital markets continue to exhibit robust liquidity for issuers across the credit spectrum into the new year. Credit spreads remain at their most competitive levels since the pre- recession era, and leverage tolerances have experienced little compression. Institutional investors continue to competefor new assets with reduced covenant protections and expansive “adjustments” to EBITDA. Commercial Banks continue to slowly regain market share after withstanding intense competition from non-bank credit providers, and BDC share prices have recovered since December. Notwithstanding the current sanguinity, institutional investors are much more pessimistic when it comes to expectations for the next 12 months. The potential for future interest rate increases, should the Fed resume its hikes, combined with fears of an impending deterioration in credit conditions, are stoking the levels of agitation in the lending community.
Minimum Equity Contribution
With an increased focus on downside protection, lenders are likely to avoid thinly capitalized deals, especially for sub $10 million EBITDA borrowers. Aggregate minimum of 40% base level equity (inclusive of any rollover) is required for most deals. As leverage levels creep up in excess of 5.00x, 40-50% cash equity (exclusive of rollover) is required. Most lenders discount rollover equity in excess of 20%.
Equity Investment and Co-Investment
Liquidity for direct equity investment (and co-investment) is still quite robust among insurance companies, family offices, credit opportunity funds, and select SBICs. Most traditional mezzanine funds will also provide up to 20% of their aggregate debt commitment as an additional strip of equity. Capital to support independent sponsors is at an all-time high, with new funds created exclusively to support independent sponsors. Promotes and carry will vary depending on the role the sponsor plays post-closing and how much, if any, of their own equity is deployed. Most carry provisions will contain performance contingencies to enhance the initial promote. While structures differ based on the circumstances of each deal, most investors are willing to sacrifice some yield for the liquidity preference.
Recap Liquidity
Recap liquidity is strong, with lenders making little distinction between accretive (acquisition) and non-accretive (recapitalization) uses of proceeds; however, sponsored transactions will achieve higher leverage and better pricing for recapitalizations. After declining between 2014-2016, dividend recapitalization activity increased in 2017 and continued to track upwards in 2018 to a four-year high (approximately $30 billion for the year).
Story Receptivity
While story receptivity remains high, it is increasingly becoming more “sector selective.” Challenged issuers in more cyclical sectors deemed most vulnerable to macroeconomic volatility are more likely to receive higher pricing, less leverage (i.e. one turn less of EBITDA) and potentially, some equity upside incentive features. The general feeling in the market is that we are near the end of the current credit cycle, and lenders will stress test more marginal credits against less generous macroeconomic conditions.