White & Case LLPHigh yield bond and syndicated loan lenders are eager to fund US buyout deals, but competition from private debt markets and high secondary buyout volumes have restricted supply
High yield bond and leveraged loan issuance for US Leveraged buyouts (LBOs) recovered strongly over the past year, but Q1 2021 saw a drop on the previous quarter as direct lenders and a high volume of secondary buyouts ate into an already tight supply of opportunities.
In the leveraged loan market, US LBO issuance for Q1 2021 came in at US$20.9 billion—more than double the US$8.6 billion of issuance in Q3 2020, but down from the US$32.9 billion recorded over the final three months of last year.
High yield bond LBO issuance, meanwhile, totaled US$1.5 billion over Q1 2021, down from US$1.6 billion in Q3 2020 and the US$1.9 billion recorded in the final quarter of last year.
Overall LBO issuance trailed refinancing, repricing and amendment activity, which totaled US$387.5 billion for high yield bonds and leveraged loans over the quarter, by some distance.
The dip in leveraged finance lending to LBO credits in Q1 2021 comes despite big increases in US private equity (PE) deal activity. US deal value for PE buyouts and secondary buyouts totaled US$160.2 billion in Q1 2021—the highest quarterly buyout deal value total since Q2 2007 and a 67% gain in the US$107.6 billion recorded in Q4 2020.
Leveraged finance investors have been eager to fund these deals, but have been constrained by the high proportion of secondary buyout deals which, at US$34.9 billion, accounted for more than a fifth of overall PE buyout and secondary buyout deal value during Q1 2021.
In secondary buyouts—where PE vendors exit to another buyout firm—debt packages can include portability provisions, which allow an incumbent debt facility to be transferred directly to the new owner, with no need for issuance of a new loan or bond. Opportunities to deploy new debt into these transactions has therefore been restricted, according to Debtwire Par analysis. A high proportion of buyout deal volumes in the US also have involved smaller companies, which lack the scale to tap leveraged loan markets.
But even for bigger credits that cross the syndicated loan threshold, the syndicated loan market has not had things all its own way. Direct lenders, who have expanded their funds under management, have been able to digest bigger deals and provide a credible alternative to syndicated loans and high yield bonds.
According to Preqin, there are 469 private debt funds currently operating in North America that have raised US$208.5 billion among them. Globally, direct lending managers have seen annual fundraising increase from US$7 billion in 2007 to US$82 billion in 2019.
With materially larger war-chests now at their disposal, direct lenders have been able to finance larger credits that would otherwise have turned to the syndicated loan and bond markets as a matter of course. One example of a direct lender funding a jumbo M&A deal is Ares Management’s provision of a senior secured credit facility to support the acquisition of WellSky, a healthcare technology company backed by TPG Capital and Leonard Green & Partners in a deal said to be worth US$3 billion. WellSky also successfully priced a US$1.25 billion term loan B (TLB) refinancing in March 2021.
Direct lenders have appealed to sponsors and borrowers not only because of their ability to write increasingly large checks, but also because they offer the convenience of a loan that can be delivered at speed without requiring syndication or modification of terms as a result of flex. When preparing to raise financing for deals, financial sponsors are now frequently running dual-track processes, with both a syndicated loan and direct lending solution on the table for consideration.
Syndicated loan and high yield bond markets, however, remain a compelling option for financial sponsors when it comes to funding deals, despite growing competition from direct lenders. Loan investors are reasonably optimistic that they will see more LBO deal flow through the rest of 2021.
Strong lender demand for new credits has supported attractive pricing for borrowers. The financial sponsors that have opted to finance LBOs in the syndicated loan markets have locked in high amounts of debt at low margins.
For example, as part of the US$3.5 billion acquisition of data software group Precisely by Clearlake Capital and TA Associates, the company secured a US$1.64 billion TLB at a margin of 4.25%.
In another LBO financing, Trilantic Capital Partners and Cornell Capital secured a US$525 million TLB priced at a margin of 4.25% in the acquisition of healthcare staffing business Trustaff Management.
The outlook for buyout activity remains positive, with financial sponsors still holding record levels of dry powder for investment, as well as feeling the pressure to catch up on deployment timetables disrupted by COVID-19.
And when it comes to financing deals, PE firms will find that direct lenders, high yield bond and syndicated loan markets are all eager to fund LBO transactions that come to market on attractive terms and margins.