With 2017 in the rearview mirror, we can safely say that the year provided for an unexpected investment environment for fund managers. A market that refused to bend to the whims of geopolitical realities and a so-called “Trump rally” buffeted strong deal activity, more robust than many were expecting. Chris Wright a managing director in Crescent Capital Group’s mezzanine debt practice, shared his thoughts on 2017 and what’s in store for the coming year.
What was the story for 2017?
2017 was a year characterized by increasing leverage with tightening spreads at the same time, so, it has been increasingly difficult to find opportunities overall. We continue to rely on private equity partners for sourcing which provides consistent deal sourcing. With all the various add-backs and synergies being proposed we have to be diligent in our due diligence in order to get a complete picture in order to develop conviction around a story. This has been a year of political uncertainty, yet at the same time there has been escalating valuations with almost no volatility; this dynamic creates fog in the investment environment.
What leverage levels did you see in deals last year?
It’s wasn’t unusual to see leverage multiples in the 6.5x to 7x range. Every week we are seeing things come out at elevated leverage multiples off a pro forma EBITDA, which includes addbacks. Its not unusual to see deals proposed at 8x. This is leverage that would be well north of 8x if you didn’t include add-backs.
What do you expect for 2018?
We are expecting a return to volatility in the market this year, especially as tax reform sinks in and we start to see what its impact will be. There is also geopolitically uncertainty and the 2018 mid-term elections to consider.
I think leverage levels will come down in 2018 as a result of monetary and fiscal policy as well as where we are in the growth cycle. But nonetheless, when we look at the fundamentals, we expect to see continued strong deal activity.
What impact do you expect tax return to have on private credit?
Tax reform might have an impact on the leverage in deals; but at the end of day, sponsors are going to continue to put the capital to work and put a capital structure in place with the lowest cost of capital. Because of the new tax provisions, lower rates and being able to accelerate the deduction for capital expenditures are positives. What is somewhat uncertain is the true impact of the limitation on deductibility of interest expense.
What are trends in financing structures?
Certainly, we’ve seen an increasing prevalence of unitranche structures in deals. There are players that can write $300 million, $400 million, $500 million checks. We are starting to see them move up market to a degree, though I don’t think $500 million-$600 million unitranche checks will become mainstream. Otherwise, it is mostly a first lien-second lien structure. You may see a stretch senior and then layer on a half turn or turn of junior debt.