Renaissance’s BofA-Led Loans Flouts Fed Underwriting GuidelinesSridhar Natarajan and Sabrina Willmer
Hellman & Friedman LLC’s $1.1 billion purchase of Renaissance Learning Inc. will leave the education software maker with debt that exceeds the Federal Reserve’s lending guideline for banks.
The $705 million of loans Bank of America Corp. is arranging to fund the buyout would boost borrowings to about six times more than Renaissance Learning’s cash flow, according to Moody’s Investors Service, and about 10 times according to Standard & Poor’s. The ratio would be above the six times threshold the Fed and the Office of the Comptroller of the Currency have told some of the biggest banks to maintain as a minimum standard.
More than six months after regulators warned that loans made to speculative-grade companies were becoming more questionable, banks are showing a willingness to carry out high-risk deals chasing underwriting revenue that grew to about $18.7 billion last year. The debt for Renaissance Learning will also exclude typical lender protections, which may leave investors vulnerable to losses in a downturn.
The acquisition “increases already high financial leverage for the company,” Adam McLaren, a Moody’s analyst who rates Wisconsin Rapids, Wisconsin-based Renaissance Learning’s debt B3, or six levels below speculative-grade, wrote in a March 27 report. “Rating reflects the company’s small size and high debt leverage.”
Mary Beth Grover, a spokeswoman at Abernathy MacGregor Group, declined to comment on behalf of San Francisco-based Hellman & Friedman. Kerrie McHugh, a spokeswoman for Bank of America, declined to comment on the new financing.
The Charlotte, North Carolina-based bank is leading the transaction, while Credit Suisse Group AG and Royal Bank of Canada are co-underwriting the deal, Bloomberg data show.
Some of the other recent financings that have flouted the Fed’s guidelines include the $1.7 billion of loans arranged by UBS AG and Deutsche Bank AG to back KKR & Co.’s purchase of Sedgwick Claims Management Services Inc., and the $700 million loan Credit Suisse arranged in January for Applied Systems Inc., a maker of software for insurance companies.
Sedgwick, the Memphis-based claims processor has leverage of about eight times earnings, interest, taxes, depreciation and amortization, after it issued loans to back KKR’s buyout, according to a Feb. 10 report from Moody’s. The same measure at Applied Systems will be about nine times, according to Bloomberg data and a Jan. 10 Moody’s report.
Regulators have been raising concern over deals with leverage levels, or the ratio of debt to Ebitda in excess of six times, according to a letter sent to some of the biggest banks last year.
“We expect this transaction to increase the company’s leverage to about 10 times at transaction close from the high-6 times area at Dec. 31, 2013,” David Tsui, an S&P analyst who rates Renaissance Learning at B-, a grade similar to Moody’s, wrote in a March 24 report on the buyout financing.
The average leverage on LBO debt is at 5.22 times, down from 6.5 times a year ago, according to S&P Capital IQ Leveraged Commentary & Data.
The Fed and the OCC have told banks to improve underwriting standards on junk-rated loans, to avoid a repeat of the losses seen during the credit crisis, when the debt performed worse than all other major credit asset classes. The advisory from the regulators has failed to shut down excessive risk taking as banks still make exceptions for deals flouting the guidance.
Debt-underwriting revenue at eight of the largest U.S. and European investment banks, including JPMorgan Chase & Co. and Deutsche Bank, rose 9.1 percent to about $18.7 billion in 2013. That was the highest total since at least 2008, according to data compiled by Bloomberg.
Renaissance Learning is offering a $475 million, seven-year first-lien loan at 3.5 percentage points more than the London interbank offered rate, with a 1 percent minimum on the lending benchmark, according to a person familiar with the matter, who asked not to be identified because they’re not authorized to speak about it publicly.
A $230 million, eight-year second-lien portion is being offered at 7 percentage points more than Libor, with a 1 percent minimum on the benchmark. Libor, a rate at which banks say they can borrow from each other, was set at 23 basis points yesterday.
The balance of the purchase will be funded with $410 million of equity from Hellman & Friedman and $35 million from Google Capital, the search engine owner’s growth-equity fund and management, according to a letter from the firm obtained by Bloomberg News.
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