Figure 1 - Purchase & Leverage Multiples (2006/2007 vs Current)
Purchase & Leverage Multiples (2006/2007 vs Current)EquityTotal as a % of Purchase Senior Mezzanine TotalPrice Debt Debt Equity Purchase2006/2007Vintage
8-10x 4x 4-5.5x 2.5-4.5x 33%
6-7x 2-2.5x 3.5x 3.5x 50%Source: State of the Middle Market discussion
Multiples of EBITDA
Note: 2006/2007 multiples were on peak EBITDA levels while current multiples are onrecession EBITDA levels. Thus on a dollar basisleverage and purchase prices have fallen significantly.
Figure 2 - Current Market Pricing For New Middle Market Loans (Primary Issuance)
Current Market Pricing For New Middle Market Loans (Primary Issuance)TotalCash PIK Interest Upfront Prepayment TotalInterest Interest Rate Fees Penalties IRRSenior Debt
L+ 6-8%w/ LIBORfloor of 2%None 8-10% 2%Not mentioned as a key returncomponent
11-13% 2-3% 13-16% 2-3%Pre-payment penalties of 3-5% stepping down to zeroover life of the loan
Source: State of the Middle Market discussion
Attractive Lending Market Likely To Continue As Banks and Irrational Competitors Not Likely To Return for aSignificant Period of Time.
When asked about competition in the middle market our speakers discussed the massivefallout of investors previously in the market place. Many of the large commercial banks are out of the market includingLa Salle, Wachovia and Bank of America. Only Wells Fargo is left lending to the middle market through its WellsFoothill subsidiary. All of the CLOs and debt vehicles financed with CLO debt are gone (Cratos, GSC Group and manymore). Hedge funds that were buying the bank loan market and leveraging the balance sheet with repo debt arecompletely gone. Several large BDCs (ACAS & ALD) are out of the market. Management said the list of remainingcompetitors is much easier to list. There are a few healthy regional banks (US Bank mentioned), a few healthy BDCs,Golub Capital, GE Capital is lending again, and TCW and Oaktree are active in the upper-end of the middle market. Allspeakers agreed that the remaining competitors are all rational investors and there are enough opportunities for everyone without the need to become aggressive on pricing. Finally, expectations were that the attractive lendingenvironment will remain for a while as irrational competitors (hedge funds & CLOs) will not receive funding for a longtime and increased regulations on banks will prohibit them from becoming aggressive in the middle market space.One additional interesting tidbit is that the upper-end of the middle market is currently less competitive than thelower-end while historically, the opposite is true. As one speaker explained, "it's much easier to find someone todaythat can make a $20 million investment to fund a smaller investment than to find someone who can make a $100million investment in a larger investment.
The pipeline For New (Primary) Investment Opportunities Is Building Rapidly And 4Q09 Should SeeSignificantly Higher M&A Volumes.
M&A activity is building with buyer and seller expectation convergence as wellas rational debt pricing being made available (rational for both lenders and equity investors). Earlier this year when thesecondary markets were yielding 20-30%, private equity investors could not effectively utilize debt for new investmentswith those types of yields; however, our PE speaker, Charles Brizius of TH Lee, stated that current yields mentionedabove for senior and mezz debt are very workable in new investment structures. To quote Mr. Brizius, "this is anenvironment where both the lender and equity sponsor can win". This is a noticeable difference from the NYC dinner where M&A activity still had many road blocks and our speakers believe that 4Q09 will see "significantly higher M&A
September 18, 2009