Banks Are Out, Investors Are In for Buyout Firms Seeking Fundingby and
Investors offer higher rates but more cost certainty for LBOs
Funds raised $85 billion for private debt, most since '08
The world’s biggest underwriters are on the outs with private equity firms looking for help to fund big acquisitions.
Leonard Green & Partners is the latest buyout shop to enlist nonbanks for help in financing deals. The firm is tapping a group of funds, including Los Angeles-based Crescent Capital Group, for its $2.2 billion purchase of medical test company ExamWorks Group Inc., according to people with knowledge of the matter.
Bank of America Corp., Barclays Plc and Deutsche Bank AG provided some of the funding and were willing to underwrite the $340 million of junior debt needed for the deal, the people said. But Crescent Capital offered something the bank group couldn’t: peace of mind.
When debt markets slumped last year, banks pulled back and direct lenders filled the void. Now that markets are crackling again, some buyout firms have stuck with direct lenders, even though their terms are often more expensive, rather than return to the banks. That’s because they offer the option to lock in borrowing costs even if credit markets go sour, a protection that banks typically don’t provide. As a result, funds like Crescent Capital that buy private debt raised a record $85 billion last year, the most since 2008, according to research from Preqin Ltd.
“In the last nine months, some lousy deal pricing has woken everybody up,” said Rajay Bagaria, a money manager at Wasserstein & Co. in New York and an author of a guide to the high-yield marketplace. “That’s given an opportunity to private-debt providers.”
Banks often ask for lower rates to lend money than the investment pools. Because they frequently parcel out pieces of the debt to other investors, they typically require, as a selling point, provisions for the rate to rise if the market weakens. Privately placed debt doesn’t need to do this because the funding isn’t syndicated.
When Apollo Global Management agreed to buy home-security company ADT Corp. in February for $12.3 billion, the firm turned to a lending arm of one of Canada’s largest pensions, the Public Sector Pension Investment Board, and its affiliates, according to people with knowledge of the matter.
In December, a fund tied to Goldman Sachs Group Inc. -- and not the New York-based investment bank itself -- agreed to buy $750 million of junior-ranking bonds to help finance the buyout of Petco Animal Supplies Inc., a person with knowledge of the financing said at the time.
KKR & Co. tapped direct lenders for the purchase of Mills Fleet Farm, announced in January, because banks wouldn’t give it “reasonable” terms on an $815 million debt package, said Scott Nuttall, KKR’s head of global capital and asset management.
“Basically, we just did it ourselves,” without bank intermediation, Nuttall said in February.
And while traditional banks still dominate lending in Asia, investment firms such as KKR, Babson Capital Management and Adamas Asset Management HK Ltd. have raised record amounts in the region to take advantage of the trend.
In the last quarter of 2015, banks refused to underwrite second-lien loans, which are riskier than senior loans, and were wary about underwriting high-yield bonds, demanding expensive terms that issuers found unappealing. In some cases, underwriters weren’t willing to provide commitments at all.
That provided the opening for private investors -- sometimes referred to in the industry as “friends and family” -- who ask for higher rates but give borrowers cost certainty in an environment where risk appetite can change in an instant.
Leonard Green needs that certainty because a provision in the ExamWorks agreement lets the company seek other buyers through June 1. Credit markets could look different by then, making the deal more expensive. But with the financing package provided by the alternate lenders, the uncertainty surrounding the riskiest portion of the funding no longer is an issue.
“Recent market volatility has made certainty of capital more important to leveraged-buyout sponsors,” Bagaria said.