Companies that need to refinance hundreds of billions of dollars of floating-rate loans stemming from the cheap-money era are increasingly tapping private credit funds for high-cost debt that lets them delay interest payments.
(Bloomberg) — Companies that need to refinance hundreds of billions of dollars of floating-rate loans stemming from the cheap-money era are increasingly tapping private credit funds for high-cost debt that lets them delay interest payments.
The new obligations, including mezzanine or junior debt and even preferred equity, are riskier for the investors providing financing, because in addition to payments potentially being deferred, if the company goes bankrupt, these obligations can be close to end of the line to be repaid. The riskiness limits the set of lenders willing to provide the funding now.
“Banks won’t underwrite this stuff,” said Chris Wright, head of private markets at investment firm Crescent Capital Group. “It’s going into the hands of private credit.”
Investors that take the risk can be handsomely rewarded. In current market conditions, mezzanine facilities are sold at a fixed price of around 13% to 14%, according to a report from Audax Private Debt, a money manager that focuses on performing companies owned by private equity firms. Interest can often be deferred on the debt. That compares with the average junk bond yield of 8.93% as of Wednesday’s close.
Surging interest rates are generally forcing companies with relatively big debt loads, including those owned by leveraged buyout firms, to get more creative when it comes to financing. In addition to junior debt, private equity management companies are taking out loans to fund their portfolio holdings.
Lenders providing junior financing say they have seen a jump in demand. Churchill Asset Management estimates that it made about 25% more junior capital investments in the first half of 2023 than the same time last year. KKR & Co. Inc. has seen more pitches for it to invest in junior debt this quarter than it saw in the past two years, according to Michael Small, a partner.
Crescent Capital reviewed twice as many junior capital deals in the first half of 2023 than the same period last year. Money managers have raised about $40 billion for this strategy thus far this year, the most since at least 2016, and up from $26 billion for all of the year before, according to Preqin, a data firm.
The junior obligations aren’t typically refinancing all of a company’s senior obligations, and not every company can get this funding. It’s typically for bigger borrowers, in industries that generate relatively stable cash flow to service the debt.
“There are size constraints, and not every capital structure can sustain junior capital – we find large, leading companies in defensive sectors most attractive,” Small said.
Because the transactions are expensive and often complicated, putting them together can be difficult. Finastra, a maker of banking and lending software, negotiated a refinancing with private lenders earlier this year. It looked to secure $1.5 billion to $2 billion of junior debt that would have had a payment-in-kind option, which allows the borrower to defer interest payments, as a way to keep a lid on its cash interest expense.
But the company struggled to find third-party lenders for that portion, and Vista Equity Partners, the private equity firm that owns Finastra, ended up contributing $1 billion of preferred equity into the business, using cash borrowed against private equity stakes.
“This can be hard money to find because it’s hard money to raise. It’s riskier than senior debt, but you get compensated for that risk,” said Rahman Vahabzadeh, co-head of origination at Audax Private Debt, who added that careful credit analysis and a focus on sectors that aren’t as exposed to economic volatility allow lenders to manage that risk.
During the era of easy money, when the Federal Reserve kept rates close to zero for more than a decade, companies largely avoided junior debt. Senior debt is cheaper, allowing them to get the lowest possible borrowing costs.
But as the Fed has hiked rates at the fastest pace since at least the early 1980s, companies have found themselves with higher debt costs, weighing on their income. There are signs that the US economy could be tipping into recession, further pressuring corporate cash flow. Deferring interest payments through payment-in-kind options is useful for many borrowers, even if means ultimately paying more.
When possible, keeping at least part of a senior facility in place while tacking on junior debt can be cheaper than refinancing an entire capital structure at current interest rates, said Scot French, governing partner at HPS Investment Partners.
“We’re seeing a big push to preserve capital structures that were put in place in 2020 and 2021. The last thing you want to do right now is take that out with a new deal because you’ll end up paying substantially more,” French said.
Companies often have provisions in their lending documents known as most-favored-nations clauses, requiring them to pay higher rates to all their senior lenders if they end up paying a higher rate to any senior lender through a refinancing. Taking on junior debt with higher rates doesn’t translate to paying senior lenders more under that provision, making junior obligations more attractive.
Flexibility Amid Stress
For much of the last year, leveraged buyout firms have been willing to inject more equity into the companies they had taken private, if it helped the borrower refinance debt. But sponsors are less willing to add equity now, and some older funds with highly indebted companies are running out of dry powder, forcing companies to consider other solutions.
“We have seen an uptick in sponsors and borrowers looking for junior options,” said Christina Lee, assistant portfolio manager, US private debt at Oaktree Capital Management. She noted the uptick is concentrated in “more stressed situations” due to rising interest rates.
Lenders that do allow companies to defer interest are making sure borrowers have a plan for ultimately meeting their obligations. But companies are eager to defer interest when they can, said Carolyn Hastings, a partner that invests in private credit at Bain Capital Credit.
“As stress has entered the market, more of these businesses have sought junior capital options, as companies and sponsors look to swap cash paying debt for the more expensive but more flexible PIK options,” Hastings said.
Deals
- Investment banks and direct-lending funds are competing to provide as much as €4 billion ($4.2 billion) of debt to finance a potential leveraged buyout of European classifieds company Adevinta ASA
- Chelsea FC has raised £500 million ($612 million) of subordinated debt from US direct lending giant Ares Management Corp.
- Apollo is in talks with Torrent Pharmaceuticals for an up to $1 billion loan to back a bid for Cipla
- Ares Management Corp is providing a direct-lending package of about £1 billion ($1.2 billion) to support the merger of two personal insurance businesses in the UK
- Vedanta Resources Ltd. is in talks with a group of lenders for a private loan of $1 billion, with proceeds to be used for the partial redemption of some of the mining company’s overseas bonds
- Bankers and private credit funds are working on a financing deal of around €1 billion ($1.05 billion) to back a potential buyout of French insurance broker Kereis as the sale process kicks off
- Bukit Makmur Mandiri Utama is seeking a loan of between $1.2 billion and $1.5 billion loan to support its bid for BHP Group Ltd.’s Blackwater mine
- Direct-lending funds are working to provide as much as £1.25 billion ($1.5 billion) for the potential buyout of the UK’s Iris Software
- HPS Investment Partners acted as the lead lender and administrative agent on a $650 million first lien senior secured term loan for Sycamore Partners’ newly formed Knitwell Group
- Software company iSolved HCM is looking to refinance a private credit loan with a roughly $550 million deal in the leveraged loan market
- A group of private credit lenders led by MidCap Financial Services has agreed to provide $305 million of debt financing to support Nautic Partners’ acquisition of Tabula Rasa HealthCare Inc.
- Silver Point Finance, the private credit business of Silver Point Capital, acted as sole bookrunner, administrative agent and joint lead arranger on a $425 million senior secured credit facility for BlueCrest, a Platinum Equity portfolio company
- French drinks maker Remy Cointreau has raised €380 million ($400 million) of private debt through the private placement market
- KKR & Co. will finance its roughly 30% stake in German space and technology company OHB SE with equity, bypassing debt markets entirely
- La Trobe Financial, a non-bank lender in Australia, is looking for another A$110 million ($69.9 million) of four-year debt to add on to an existing A$400 million term loan B
Fundraising
- Blackstone Inc. is looking to raise over $10 billion across two private loan funds in Europe and the US, as the firm seeks to further capitalize on the growth of private credit
- Wells Fargo & Co. and Centerbridge Partners are joining forces on a direct-lending fund targeting at least $5 billion, including $2.5 billion of equity commitments, the latest in a flurry of bank efforts to gain share in the $1.5 trillion private-debt market
- DWS Group, the asset management arm of Deutsche Bank AG, is looking to raise around $1 billion to lend to European corporate borrowers in private markets
- Private credit funds with more than $5 billion under management took the largest share of capital raised by the asset class in H1 2023, according to data from capital markets information business PitchBook
Job Moves
- Arrow Global Group Ltd has hired two senior members for its real estate and credit and direct lending teams: Zachary Vaughan and Toni McDermott
- Golub Capital, a direct-lending firm and credit asset manager, hired Karim Salazar Antoni as a director to serve the US offshore market alongside institutional and private wealth investors in Latin America
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(Updates with Crescent Capital’s deal reviews in paragraph 7)
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