NEW YORK, Dec 17 (Reuters) - Lenders scaled back on underwriting large debt-laden buyouts for low-rated companies in the fourth quarter, signaling that U.S. warnings to regulated banks against these highly leveraged transactions are gaining traction.
Loans testing regulatory guidelines keep getting done, but banks appear to be more judicious, based on new Thomson Reuters LPC data, even as uncertainties about compliance linger.
“There is still a wide discrepancy about what works and what doesn‘t,” one senior banker said.
The largest corporate leveraged buyout deals this quarter carried debt 6.54 times earnings, on average.
Leverage over six times debt to earnings before interest, tax depreciation and amortization (Ebitda) is problematic, and could spur penalties, under the guidelines issued in March 2013 to banks regulated by the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp.
While still high, the debt ratio fell from 6.96 times in the third quarter, the loftiest level since holding above seven times through most of 2007.
TIBCO Software’s $2 billion loan backing its buyout by Vista Equity Partners inflated the fourth quarter average, with Moody’s Investors Service estimating debt to Ebitda of 11 times. Factoring in substantial synergies and adjustments on that deal provided by the sponsor, however, the average debt to earnings for large corporate buyouts fell further to 6.28 times, LPC data show.
Regulators’ latest attempts to clarify the guidelines, with a frequently asked question series and senior banker meetings last month, left many lenders still grappling with complex underwriting decisions.
Bankers are increasingly prudent in following the guidelines, which also deem loans as “criticized” or “special mention” if companies cannot repay all senior debt or half of total debt from free cash flow in five to seven years. Wiggle room remains, as does some confusion, bankers agree.
“It’s more difficult to pull together underwriting groups, but there’s still plenty of opportunity for deals over six times leveraged,” including PetSmart Inc and Riverbed Technology Inc, the senior banker said. “There is a huge swath of banks in there that haven’t seen this as a problem.”
Citigroup, Nomura, Jefferies, Barclays and Deutsche Bank this week lined up commitments for $6.95 billion of debt to finance the $8.7 billion purchase of PetSmart by a private equity consortium led by BC Partners. The funding for the largest 2014 leveraged buyout would put leverage around 6.5 times, based on December 14 numbers from PetSmart.
While several banks backed away, worried the deal would not pass guidance, others determined the loans will comply based on quick debt repayment, LPC reported.
Separately, Thoma Bravo LLC and the Ontario Teachers’ Pension Plan on December 15 agreed to buy network equipment manufacturer Riverbed for $3.6 billion, which would put leverage above six times, several banking sources said.
While both deals would top the six times gauge, they fit into a growing trend away from even greater leverage. The share of deals levered above seven times dwindled to 31 percent in the fourth quarter from 55 percent in the third quarter and 42 percent in second quarter.
“Anything over seven times is a no-no,” said another banker.
It will be clearer next year whether a sustained shift toward lower leverage will take hold.
“The proof will be in 2015, where you will start to see the trends after deals that were already in the pipeline earlier this year were done,” said Jonathan DeSimone, a managing director at Sankaty Advisors in Boston.
Some of the most highly leveraged deals, though, will keep swinging to lenders outside of the purview of regulators pressing the guidance.
“As an investor, we certainly value the trading liquidity that the established counterparties offer in our market, and we absolutely put a premium on those situations versus those where the deal is not going to trade to the same extent,” DeSimone said. “We would expect cost of capital to be lower than for an instrument syndicated by an institution that hasn’t invested as much in its trading platform.” (Editing By Michelle Sierra and Jon Methven)