Gap Analysis: Unlocking Opportunities in Private Junior Debt

The syndicated debt markets are open for very large companies―a $5.5 billion financing of a $14 billion buyout that priced this month proves it. We think that is good news both for credit markets and for those seeking capital.

However, our analysis of the few large syndicated LBO deals this year suggests that the market is only open for issuers with relatively high ratings and very large equity cushions. We think this will create an opportunity for junior debt given that it tends to have a lower impact on issuers’ ratings than senior or secured debt.

The Syndicated Market’s Gears Are Turning Again

In 2023, six leveraged buyouts with transaction values above $500 million have taken place in syndicated markets (Exhibit 1). Most notably, $5.5 billion in syndicated loans and senior secured bonds came to market in a buyout of Emerson Electric’s Climate Technologies business.

Relationship banks and direct lenders provided the original financing commitment for Emerson in November 2022. At that time, there was no syndicated option available. Under the terms of the original financing, the sponsor had an option to pay the financing parties a small fee to replace their commitments with an alternative solution. Based on the pricing of the syndicated solution, estimated annual savings in financing costs are some $180 million.

So, why not raise more syndicated debt given the significant cost savings?

EXHIBIT 1

2023 LBOs with Transaction Values Exceeding $500m

Markets Are Open, but Only under Certain Conditions

Looking more closely at the deals of 2023, syndicated market transactions have had to clear two high hurdles: relatively high ratings and equity checks much larger than historical averages.

Transactions this year have targeted ratings of mid-single-B or better. The premium the market requires for these ratings, or the spread between mid-single-B-plus and lower-rated loans, is at a cyclical peak (Exhibit 2). That, in turn, implies that the amount of leverage accessible through a syndicated solution may be constrained. First-lien syndicated debt commonly comes with leverage of 5.0x EBITDA, compared to an average of 3.0x EBITDA for this year’s crop of deals.

EXHIBIT 2

Syndicated Loan Spreads Are at Three-Year Wides

Sponsors appear to have compensated for these lower levels of leverage with significantly higher equity capitalizations (Exhibit 3). From 2007-2022, leveraged buyouts of corporates with EBITDA of more than $50 million ranged from 30%-46%. Equity on the syndicated LBOs this year has averaged 67%, including one transaction with an astonishing 89% equity cushion. That is a sizeable increase compared with the trend of the past 15 years.

EXHIBIT 3

Equity Cushions in Corporate LBOs Have Spiked This Year

How Many More Emersons Can There Be?

The Emerson transaction is certainly a sign of health in the syndicated markets and could be a catalyst that reopens the large cap buyout market. The typical capital structure for those large cap buyouts, however, remains to be seen.

We believe acquirers will find themselves unable (or unwilling) to raise as much syndicated senior debt due to the current cost of debt rated mid-single-B or higher. We do not think greatly elevated equity checks are likely to become the norm, either. If we are right, this will leave large cap, high quality LBOs with a gap in their capital structures.

We think many sponsors will turn to private junior debt to fill that gap (Exhibit 4). As the market opens up, we believe sources of flexible capital, including private junior debt, could become very important liquidity solutions.

EXHIBIT 4