After a busy January which saw approximately 73 deals close (the bulk of which were in the middle market), liquidity conditions for February seemed about as aggressive as they have could get. However, the final week of February was one for the history books in global financial markets, Treasury yields crashed to record lows, the U.S. stock market plunged into a correction at the fastest pace on record, and assets like gold proved to be less of a haven than usual. February showed us all a world that seemed to be changing dramatically -- and alarmingly fast. The below capital markets summary from SPP Capital Partners can be viewed in full here: http://sppcapital.com
Minimum Equity Contribution
Notwithstanding the more aggressive quantitative pricing and leverage metrics, from a qualitative perspective, most lenders remain quite wary of thinly capitalized deals. A minimum aggregate of 40% base level equity (inclusive of any rollover) is still required for most deals, with at least 20%-25% minimum new cash equity being the norm. As leverage levels creep up in excess of 5.0x EBITDA, 40%-50% cash equity (exclusive of rollover) is required.
Equity Investment and Co-Investment
There is no dearth of liquidity for both equity investment and co-investment in the new year, as well as robust support for independent sponsors (especially in the case where an independent has secured an LOI at sub-auction level pricing). Capital for direct equity investment (and co-investment) is plentiful among insurance companies, family offices, and select BDCs and SBICs. Unitranche providers increasingly request equity co-investment to complement their debt investment, though usually this is not a condition required for the debt component. The number of credit opportunity funds capable of providing both debt and equity tranches has increased over the course of 2019 as well. 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 liquidity preference (i.e. - preferred vs. common shares).
Recap Liquidity
Liquidity conditions for dividend and share recapitalizations remain solid, particularly for sponsored transactions. In most cases, pricing and terms for “non-accretive” recapitalizations mirror those of more “accretive” uses of capital such as acquisitions and growth capital. Though less bountiful, non-sponsored issuers also have access to recapitalization dollars, albeit with slightly less aggressive leverage tolerances. If in fact macroeconomic conditions do materially deteriorate, recap liquidity will certainly be negatively impacted (or potentially shut down).
Story Receptivity
The first quarter of the year is typically the most advantageous time of the year for “storied” or more credit challenged transactions. Deal flow is slower, lenders are back at full capacity after the typical Q4 crush of closings, and portfolios are fresh for deployment. 2020 is no exception, and given the broader highly favorable overall market dynamics, there is no better time for smaller, more marginalized credits to come to market. While lower middle market issuers, especially those in cyclical sectors, will not achieve the same level of leverage or pricing compression associated with larger, less cyclical credits, competition is still formidable and execution risk, is in large part, diminished. Lenders are displaying a willingness to craft covenant packages to accommodate unique circumstances where EBITDA may dip and leverage may spike for a quarter or two without triggering a default.