In the third quarter, the middle market was the wallflower to the large-cap market’s social butterfly. At $2.9 billion, total volume edged past the second quarter’s $2.5 billion, but year-to-date business is way off, at $7.5 billion, versus $12.6 billion in the first three quarters of 2011, according to LCD.
At a time when middle-market loans should’ve been flying off the shelf, small-cap business barely got off the ground. The disconnect reflects the absence of M&A and few outstanding refinancing candidates. Dividend volume dropped to 6% of year-to-date volume, from 18% in the year-ago period, and refinancing is down to 25%, from 32% last year.
Bankers say sponsors already have turned over most of their portfolios. This week’s fourth-quarter opener was weak, to put it mildly. Of roughly 30 launches through Thursday, only one issuer – ComPsych – generates less than $50 million of EBITDA, according to sources. Some of the others generate EBITDA in the area of $60 million, and arguably still belong in the realm of middle-market lenders, especially when institutional accounts have plenty of bigger fish to fry, such as Hertz, Getty Images, and Valeant Pharmaceuticals.
Mandates have been hard-fought, with the middle market getting squeezed at both ends. Finance companies – Ares Capital, GE Capital, Golub Capital, NXT Capital, Prospect Capital, Monroe Capital, and investors such as Oaktree Capital, among others – are gobbling up the lower middle market with unitranche financing. LCD does not formally track unitranche volume, but Homecare Homebase shows the pricing pressure lenders are feeling to compete against the unitranche machine.
Homecare Homebase, a portfolio company of Cressey & Co. and SV Life Sciences, last week closed a $75 million senior secured financing via CIT Group, according to sources. The $75 million financing is split between a $5 million revolver and a $70 million term loan. Pricing is L+400, with a 1% LIBOR floor, according to sources. The term loan was issued at 99.
Club loans like Homecare Homebase sometimes net below-market rates, although L+400 is well inside the third-quarter averages of L+552 for institutional debt and L+511 for pro rata paper, according to LCD. The sponsors and management used proceeds to refinance debt and fund a roughly $70 million dividend payment. Management maintains majority control of the software business, while Cressey and SV Life own a minority stake, sources note.
There is no junior debt in the capital structure, and that highlights another party fighting for business: mezzanine providers. Mezzanine debt is tightening to compete with unitranche rates, which are under pressure as well, sources say. The $115 million in mezzanine debt backing the buyout of Centerplate is rumored at 11.75% all-in, according to sources. Meanwhile, the unitranche loan that closed this summer forBenihana was under 9%, they say. Over the past two years, mezzanine has hovered in the 12-14% range, all-in, while unitranche loans historically have priced in the 9-10% area.
The lower segment of the market always has been the turf of club-style executions, but that’s especially the case today as competition for sub-$25-million EBITDA deals pushes traditional lenders up the food chain. Pro forma EBITDA has risen steadily for syndicated deals in 2012. Average pro forma EBITDA in the year to date is a record $37.4 million, up from $37.1 million in 2011, $34.1 million in 2010, and $27.9 million in 2009.
M&A-related business has shown signs of life in recent weeks, but arrangers are treading cautiously. Buyers and sellers remain far apart on price, and tentative agreements are vulnerable to collapse at the negotiating table.
Middle-market purchase-price multiples for LBOs dropped further in the third quarter, averaging 7.2x, down from 8.3x in the second quarter, according to LCD. In the year to date, multiples stand at 7.6x, down from 8.2x in the first three months of 2011 and from 8.4x in 2010.
By contrast, multiples for large-corporate LBOs jumped again in the third quarter, with private equity firms chasing after public companies, which have seen their stock prices soar over the past year. Third-quarter multiples for large LBOs hit 9.6x, up from 7.9x in the second quarter.
Tack-on purchases kept M&A alive July through September. That didn’t move the meter much in terms of volume, however. Acquisitions accounted for 14% of total middle-market volume, down from 21% in the second quarter. In the year to date, acquisitions are 21% of total volume, up from 8% in the same period last year and 15% in 2010.
Some issuers left the nest in the third quarter, with Ollie’s Bargain Outlet, Fort Dearborn, Camp Systems International, Peak 10, and other erstwhile middle-market names graduating into a broader pool of capital. While the optimist would say these growing businesses are a sign of an improving economy, the pessimist would argue that the capital markets are off their rocker.
3Q stat snapshot
- Pricing: Institutional pricing for middle-market issuers with a single-B rating profile averaged L+550 in the third quarter, down from L+608 in the first half of 2012. Pro rata pricing fell to L+506, from L+535 in the first half.
- Pricing premium: Institutional accounts earned an 89 bps premium, on average, for middle-market paper with a single-B rating profile over large-corporate single-B loans: L+550 versus L+462. That’s down from 114 bps in the first half: L+608 versus L+494.
- Leverage: Senior leverage eased to an average of 3.7x, from 3.9x in the second quarter, but remains above the first quarter’s 3.4x multiple. Total leverage ended September at 4.3x, wide of 4.2x in the second quarter and 3.8x at the end of March.
– Kelly Thompson
Follow Kelly on Twitter @MMktDoyenne for middle-market financing news.
* Generally, LCD defines middle-market issuers as those that generate up to $50 million of EBITDA, though classifying an issuer as middle market sometimes is more art than science. LCD’s middle-market data include loans that are large enough to be syndicated (typically term loans totaling $100 million or more). The data also include small, club-size loans, but this segment of the market contributes only slightly to the data set. Bilateral loans are not included in LCD’s middle-market data. Research on bilateral loans is available to subscribers via LCD’s SME (small-to-medium enterprises) group.