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Leverage levels peaking again on US mega buyouts

By Jonathan Schwarzberg

NEW YORK, March 22 (LPC) - Leverage levels on US private equity buyouts are returning to record levels and private equity firms’ equity checks are shrinking as banks underwrite more aggressive loans, safe in the knowledge that they will not be penalized by regulators.

Average leverage levels of 6.8 times in 2019 so far are rebounding towards a recent record of 6.97 times in the third quarter of 2018, before year-end volatility cooled the market and the number fell to 6.09 times, according to LPC data.

As leverage and the amount of debt that sponsors are piling on businesses is rising, the amount of equity they are contributing is falling. Equity checks of 35.7% in the first quarter of 2019 so far are lower than 38.7% in 2018 and 43.3% in 2017, the data shows.

Huge highly leveraged buyout loans are contributing to the spike, including US$3.2bn of loans for travel commerce platform Travelport and a US$6.4bn dual-currency loan for Power Solutions, which backs the buyout of Johnson Controls’ battery unit.

Travelport’s loans had leverage of 7.6 times, according to Moody’s Investors Service. Banks marketed adjusted leverage Brookfield Business Partners’ buyout of Power Solutions buyout at 6.1 times, but Moody's put the number higher at 7.5 times.

“People (bankers) are not as worried about leverage now. They don’t want to underwrite bad deals, but they’re willing to go up maybe half a turn of leverage without too much fear,” a senior leveraged finance banker said.

Current leverage ratios are the highest debt-to-Ebitda levels seen since the second quarter of 2007, before the financial crisis, when leverage also averaged 6.8 times. This is due to regulators giving more freedom to arranging banks and investors’ hunt for higher yield, market participants said.

US regulators implemented Leveraged Lending Guidance (LLG) in 2013 to limit systemic risk. This imposed extra scrutiny on loans with leverage greater than 6 times and also required all secured debt or half of total debt to be able to be paid down within five to seven years.

LLG was relaxed last year when government agencies said that it was guidance and not a rule, which is encouraging banks to arrange more highly leveraged deals without fear of regulatory penalties. It is also producing riskier deals and more aggressive market conditions, another senior leveraged finance banker said.

“You used to see one bank willing to provide more leverage,” a head of leveraged finance said. “But now multiple banks are willing to underwrite these kinds of deals and that has led to more aggressive conditions.”

Pricing on Power Solutions loan was reduced after a successful syndication, but investors demanded higher pricing on Travelport’s loan, a CLO investor said, as lenders were worried about how much leverage was being added.

Travelport priced its US$2.8bn first-lien loan at 500bp over Libor, above price guidance of 450bp-475bp over Libor. A US$500m second-lien loan priced at 900bp over Libor, at wide end of guidance of 850bp-900bp.

Although Power Solutions’ buyout was syndicated successfully, its equity check was only 22.7% of the US$13.2bn purchase price. The US$3bn size of the check helped some investors to get comfortable despite the low equity amount, sources said.

Retail investors withdrew another US$407.7m from loan funds this week, in the 18th consecutive week of outflows, but institutional investors are liquid and CLO issuance is picking up.

Borrowers are being helped by investors’ belief that a strong US economy will support indebted companies through 2019, investors said. The leveraged loan default rate dropped to 0.95% this month, which is the lowest level since 0.81% in April 2012, according to JP Morgan. (Reporting by Jonathan Schwarzberg; Editing by Michelle Sierra and Tessa Walsh)