They’re piling loans onto Corps that are being purchased in leveraged buyouts, and when the dust settles, companies like healthcare services provider Envision Healthcare Corp could have total debt around 7.5 times a measure of earnings.
A year ago banks believed, with good reason, that regulators would view any ratio above six times as too high. Then in February of this year, government officials hinted that they were easing their enforcement of that guideline, and the entirely foreseeable came to pass.
While average levels of indebtedness are only edging higher in acquisitions, leverage is jumping in the riskiest deals. Regulated banks are stepping into an area previously dominated by less-regulated foreign lenders and smaller investment banks.
“Banks are beginning to push the envelope,” said Steven Oh, global head of credit and fixed income at PineBridge Investments in Los Angeles. “What had kept leverage muted had been the leveraged lending guidance,” he said, referring to regulatory guidelines for the loans.
And it’s not just debt levels: protections for investors in the more than $1tn leveraged loan market are weakening too. Looser strictures and safeguards will likely lead to bigger losses for debt investors whenever credit markets start to cool. Money managers including Pacific Investment Management Co and BlackRock have been cutting back on their corporate debt exposure in part for this reason.
“Every week you come in and think they can’t get any looser, but they do,” said Frank Ossino, a senior portfolio manager at Newfleet Asset Management, referring to lenders and the terms on loans. The higher debt levels are being fuelled in large part by greater borrowing in the loan market. About 34%, or $171bn, of all institutional loan launches so far this year through Tuesday have been to finance takeovers, buyouts, or dividends.
That figure was closer to $160bn at the same time last year.
KKR & Co’s $8.3bn purchase of BMC Software will increase debt levels at the information technology firm to about 7.5 times EBITDA, according to people familiar with the transaction, who asked not to be identified because the matter is private.
That comes just two years after an earlier debt deal at the company drew a warning from regulators over risks. Lenders in that deal include Credit Suisse Group AG and Goldman Sachs, which both declined to comment. Another KKR buyout deal, for Envision Healthcare Corp, will also have leverage of about 7.5 times, people familiar with that deal said. Lenders including Citigroup and Credit Suisse, both of which declined to comment.
And Vertafore got a debt financing last week including a $1.6bn loan that increased leverage at the software company to about the same level, according to separate people familiar with the matter. Moody’s Investors Service put the leverage even higher at 10 times, following the company’s plan to pay a “large distribution to shareholders” with proceeds. Representatives at the software firm didn’t immediately respond to a request for comment. Representatives for Nomura Holdings, which led the financing and isn’t subject to US regulated-bank guidelines for leveraged lending, declined to comment.
Representatives for Bain Capital, which along with Vista Equity Partners agreed to buy Vertafore in 2016, also declined to comment.
Leverage levels had been showing signs of edging higher even before regulators loosened their enforcement.
The US Treasury Department released a report in June 2017 that recommended banks look at a broad array of metrics when underwriting a leveraged loan, and not just focusing on the 6 times ratio. As of September 2017, about 6% of LBO’s had 7 times or more debt than EBITDA, about double the year before.
Morgan Stanley said in a report on Friday that leverage is at an all-time high in newly made US loans known as first-liens, whose holders have first priority if the company fails.
Borrowers of such loans had debt equal to a record 4 times a measure of earnings in the first quarter, up from 3.92 times at the end of 2017, the report showed. It’s also rising in high- yield bonds, the bank’s analysts said.
For buyouts, lenders often talk down the importance of leverage by emphasising how measures of indebtedness will fall in the future, because of, for example, higher earnings before interest, taxes, depreciation and amortisation.
That shows up in “add backs,” or adjustments to EBITDA.
