Industry Q&A – Marc Cooper with our Head of Financing Advisory

April 4, 2024

Industry Q&A – Marc Cooper with Joseph Stein

Since joining Solomon Partners in 2001, Joseph Stein has arranged more than $20 billion of capital for acquisitions, general corporate purposes, special situations, and recapitalizations.

We discussed the state of the private credit market and financing options available to companies today.

Joe, what role do boutique investment banks play in facilitating financing transactions?

Boutique investment banks, like Solomon, have deep expertise in private capital-raising. Acting as a placement agent, they can play a crucial role in arranging loans from private, non-bank lenders.

In our case, we don’t engage in trading activities or research coverage, allowing us to focus solely on serving our clients’ best interests. We don’t have our own capital like a bank, so we are not beholden to our own solution.

Our job is to seek out the most competitive financing that meets our clients’ objectives, so we go to the broader market to deliver it. At the end of a successful process, clients may rest assured that we have secured the very best terms available in the market.

What types of financing solutions do you most commonly see in the market today?

Currently, the most prevalent structure in the private market is a unitranche structure. This is effectively a senior secured loan, with an increased leverage level such that the borrower is able to avoid raising a separate second lien facility. This streamlined structure negates the need for an inter-creditor agreement between separate lenders in the first and second lien loan tranches, which can make the documentation and closing process more efficient and less costly.

Where does financing typically come from?

Banks were historically the primary source of capital for companies seeking to borrow. Since the global financial crisis 15 years ago, there has been a steady rise of institutional credit funds or direct lenders, who have filled the void created as banks have retreated from lending efforts as a result of the burden of increased scrutiny and regulation.

Institutional investors have flocked to this space, enticed by the prospect of a floating rate, senior secured instrument managed by highly trained and skilled credit professionals. High profile, large funds are growing rapidly with additional fundraising and competing directly against banks in increasingly large deals, while funds serving various sub-sectors of the market continue to thrive.

How are the leveraged loan markets and private markets performing?

As of the end of the first quarter of 2024, both the private and leveraged loan markets are open and conditions are favorable for borrowers. Conditions have been strong since the second half of 2023, and we expect clients should have continued access to them for the foreseeable future.

How does the private credit market compare to the broadly syndicated market?

The weekly news cycle and other technical factors have a greater impact on the broadly syndicated market, whereas the market for private transactions tends to be a bit steadier. In fairness, there is a 75-100 basis points pricing premium in the private market as it is a “buy and hold” environment for lenders.

Interestingly, there has been a historic convergence in pricing and terms of the two markets over the last 12-15 months as private deals have gotten larger and proved a viable alternative to the broadly syndicated market.

Which industry sectors have access to the direct lender community?

From what we’re seeing, all of Solomon’s industry coverage sectors have access to the direct lender community, but sectors such as business services, healthcare, data analytics, and software are seen as particularly attractive.

What makes a credit particularly appealing to the direct lender community?

Any company producing reliable cash flow with a competitive and defensible position in a sector is a good candidate for debt financing. A company with a recurring revenue profile is considered especially appealing, as it provides greater forward cash flow visibility. This characteristic has made the data analytics and software sectors particularly hot. We tend to work with companies with $10 million or greater of earnings before interest, taxes, depreciation, and amortization – known in the industry as EBITDA. Companies of that scale are viewed more favorably by lenders, who use size as a proxy for risk.

How has the market been performing in terms of volume and interest in transactions?

Volumes have been up recently and there has been renewed interest in transactions. Solomon has been receiving a steady stream of calls from both clients seeking financing and lenders eager to deploy capital.

Are you seeing a difference between lenders’ willingness to finance large versus mid-sized companies?

The market is bifurcated into two big groups: the large-cap market and the middle market. The large-cap market is a growing phenomenon where companies with $100 million or more of EBITDA are accessing the private market as an alternative to the leveraged loan or broadly syndicated market. Credit spreads are tightest here at 500-550 basis points and leverage levels can exceed 5x.

The middle market has traditionally been a core market for Solomon. Spreads are wider at around 575-625 basis points and leverage is more modest at an average of 4.5x. Of course, certain stronger credits can access greater leverage.

How do lenders determine an appropriate leverage level?

As a first step, lenders often look at a leverage multiple calculated based on Last Twelve Months (or LTM) EBITDA. Lenders will heavily scrutinize any adjustments embedded within this EBITDA figure and are typically more conservatively oriented in this respect than equity investors.

Given the current rate environment, lenders are heavily focused on Fixed Charge Coverage Ratio compliance, which demonstrates the ability of the borrower to service the projected cash interest burden. Finally, as a key underwriting criterion, lenders are holding on to the implied Loan-to-Value ratio, with most lenders adhering to a 50% minimum LTV requirement when factoring in a leverage multiple against an estimated valuation multiple.