The changing dynamics of the debt markets have resulted in greater efficiencies for the types of leverage available for mid-market private equity investments. Specifically, private equity funds now have greater opportunities to economically finance and refinance mid-market investments in whole or in part with high yield debt securities, as well as with mezzanine loans.
Historically the high yield market has demanded that inaugural issuance sizes exceed $300 million in aggregate principal amount, making the high yield market either inaccessible or inefficient for most mid-market private equity funds and their portfolio companies. In a search for more meaningful yields, however, high yield investors are accepting more illiquid issuances without substantial incremental cost. For example, in the last 16 months, 46 first-time high yield issuers accessed the market with offering sizes between $75 million and $300 million. The issuers have raised total proceeds of $9.6 billion to finance acquisitions (thereby reducing required equity investments), refinance existing indebtedness and fund dividend recaps and other corporate uses.
High yield debt securities and traditional mezzanine loans present different opportunities for those in search of leverage beyond what traditional senior lenders are willing to provide or on different terms. While both offer longer maturities and lighter covenants than traditional senior loans, they have several distinguishing features and different execution. High yield debt currently offers highly competitive pricing in the present low interest environment with no equity kickers, no financial or maintenance covenants, relatively looser negative covenants and lenient events of default. A number of high yield investors typically take an allocation of deals intermediated by DCM bankers, rather than a single or few funds handling the transaction directly. Mezzanine debt also offers competitive pricing, but with direct execution through a single lender or small group of lenders and a corresponding ability to increase the size of the facility if necessary.
Both markets are continuing to evolve in ways that make them more welcoming to mid-market private equity funds and their portfolio companies. For example traditional mezzanine lenders are increasingly willing to structure transactions to incorporate key features of “private high yield” debt into a new hybrid product. And high yield investors are increasingly willing to invest in issues of smaller size and with less trading liquidity than has historically been the case.
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