The Waiting Game

For the fifth consecutive month in 2025, we see no changes to its Market-At-a-Glance metrics, a striking contrast to the volatility roiling public and syndicated debt markets. Despite geopolitical tensions, tariff uncertainties, and fluctuating recession odds, private market conditions remain steadfastly issuer-friendly; leverage multiples, pricing, and terms in June mirror January’s levels, which were among the most competitive since 2007. Consistency in pricing, leverage, and liquidity is not a reflection of market confidence, however, but rather a symptom of inertia. The long-anticipated resurgence in M&A activity remains elusive; deal flow continues to underwhelm, with new money transactions (acquisitions, growth capital, and leveraged recaps) still lagging historical norms. For market professionals this June, “the waiting is the hardest part.”

Public Markets Volatility Versus Private Market Stability

The public markets tell a different story. The ICE BofA U.S. High Yield Index Option-Adjusted Spread (OAS) spiked to 485 basis points on May 15th before settling at 325 basis points by June 5th, a 33% swing in just three weeks (source: FRED). Investment-grade bonds (ICE BofA U.S. Corporate Index) saw spreads climb from 93 basis points to 130 basis points and back to 95 basis points over the same period, reflecting a 40% fluctuation (source: FRED). Recession odds, per Polymarket, peaked at 60% in early May but have since moderated to 35% by mid-June. These gyrations correlate with ongoing trade policy uncertainties, yet the private market remains unmoved.

Ample Liquidity, Limited Opportunities

The resilience of private market liquidity stems from two persistent drivers: an unprecedented $570 billion in private credit dry powder (source: PitchBook, June 2025) and a continued scarcity of new money deal flow (M&A, leveraged buyouts, and growth capital). PitchBook notes that private debt dry powder grew by 0.6% from May’s $566.8 billion, with fundraising holding steady despite a sluggish M&A environment. New money issuance in Q2 2025 accounted for just 12% of leveraged loan volume, compared to a five-year average of 30% (source: Bloomberg). This imbalance—abundant capital chasing limited opportunities—keeps lenders aggressive, offering competitive pricing and terms.

Why M&A Activity Remains Slow

M&A activity, or more correctly stated, the lack of M&A activity, continues to be the prime culprit for the current private market doldrums. Bloomberg reports that Q2 2025 saw only 350 private equity exits valued at $160 billion, down from Q1’s 402 exits at $186.6 billion. The backlog of unsold portfolio companies now exceeds 12,500, with 4,000 held for over five years (source: PitchBook). Since 2019, the average hold period (i.e., years to exit from date of first investment) has increased from 7 years to 8.2. According to E&Y Parthenon, “For U.S. deal volume over $100m, Q1 [2025] showed early positive signs relative to 2024, surpassing last year’s levels by about 9% in total (6% for corporate M&A and 16% for PE). However, slower monthly momentum in dealmaking activity at the end of Q1 along with slower expected GDP growth, persistently elevated policy uncertainty and heightened financial market volatility, will challenge dealmaking through the rest of the year. We estimate that total US deal volume (PE plus corporate M&A) will only rise 1% in 2025, following a 19% advance in 2024… In our pessimistic scenario—where GDP growth and corporate profits are weaker, inflation hotter and interest rates higher—deal volume is expected to contract by 6% in 2025.” Getting more granular, there is an increasing body of data supporting even a sharper decline in M&A activity through year-end:

• Q1 2025: Deal counts declined sharply (down -19%) from Q4 2024, despite an increase in announced deal values
• April 2025
  • US M&A activity declined overall.
  • Deal volume exceeding U.S.$100 million fell 18.7% from March.
  • Deal volume is down 24.8% year-over-year (YoY) for deals exceeding US$100m.
  • Corporate M&A deal volume (>$100 million) dropped 30.5% YoY.
  • Private equity deal volume (>$100 million) fell 3.6% YoY.
  • U.S. M&A deal activity decreased 1.6% from March.
•  February 2025: Saw the fewest monthly deals announced in the past four years (3,208 deals).

Leveraged Recaps Gain Ground

This scarcity of actionable financings amplifies opportunities for leveraged recapitalizations, as sponsors seek liquidity without exiting at depressed valuations. Lenders are responding with leverage tolerances up to 4.75x LTM EBITDA for issuers above $25 million in EBITDA and pricing and terms typically reserved for accretive transactions. Even lower middle market issuers (EBITDA < $10 million) can achieve aggregate leverage multiples of 4.0x in a leveraged recap scenario. But the foundation underpinning these market conditions is fragile. Should inflation re-accelerate or recession fears materialize, the private market will not be immune. Lenders are already preparing for a potential down-cycle, with greater scrutiny of covenant structures, increased diligence, and a renewed focus on cash equity contributions.

Conclusion: A Fragile Standstill

In short, the private market is in a state of suspended animation—waiting for clarity, waiting for deals, and waiting for the next macroeconomic shoe to drop. Until then, the music plays on, but the tempo is slowing… and “The waiting is the hardest part.”

Tone of the Market

As we hit the halfway mark of 2025, the private market remains a bastion of stability in a world of economic turbulence and geopolitical volatility. Despite tariff tantrums, recession whispers, and traded market rollercoasters, private credit spreads and leverage multiples are as steady as a metronome. Private credit dry powder, still at a record $566.8 billion, continues to fuel aggressive terms, while a drought in new money deal flow—acquisitions, LBOs, and growth capital—keeps lenders hungry for opportunities. M&A deal flow in particular has gone from weak to downright anemic, with the deal count down 35% year-over-year. Pricing, leverage, and terms in June are virtually identical to January’s and among the most issuer-friendly since pre-Great Recession days. Yet, to many market participants, this issuer-friendly environment feels like a calm before the storm; interest rates have “been higher for longer,” and cyclical sectors struggling under the combined burden of inflationary tariffs and increased capital costs could face an inflection point leading to increased defaults. Though such a situation may not precipitate a full-blown “credit meltdown,” at the very least, it could lead to a more pronounced “risk-off” issuance environment.

Minimum Equity Contribution

The level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders remain fixated on a minimum 50% LTV (i.e., equity capitalization of 50% of enterprise value), and actual new cash in a deal should also constitute at least 75% of the aggregate equity account. While lenders will certainly give credit to seller notes and rollover equity, the cash equity quantum continues to be an essential and primary underwriting consideration. The good news is that non-bank lenders, private credit funds, insurance companies, BDCs, and SBICs are all potential sources of equity capital as well as debt capital, and in many cases, are more than happy to shore up and backfill the equity account directly.

Equity Investment

Liquidity for both direct equity investments and co-investments is robust in the new year, and in most cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Importantly, equity investment can take a variety of forms (preferred, common, warrants, even HoldCo notes) depending on the unique requirements of a given deal. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real “skin in the game” (i.e., a meaningful investment of their own above and beyond a roll-over of deal fees). While family offices remain the best source of straight common equity, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing combined debt and equity tranches.

Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

A Steady Private Market in an Unsteady World

For the fourth consecutive month this year, we are not making any changes to its Market-At-a-Glance metrics. While the mere maintenance of the status quo would hardly be noteworthy in most economic environments, given the magnitude of the shifts in pricing and yields in the traded debt markets (public, 144A, and syndicated loans) for the same period, it is actually quite remarkable. The lack of private market volatility in 2025 in the face of heightened geopolitical tensions, unprecedented economic uncertainty, and an on-again/off-again trade war between the two largest economies in the world has many private market participants wondering why “Nothing Changes Around Here.”

Public Credit Spreads Swing—Private Terms Hold Firm

To be more specific, the CE BofA U.S. High Yield Index Option-Adjusted Spread on March 24th was ~305 basis points; by April 7th (five days after “Liberation Day”), that spread increased to 461 basis points; by May 6th, that spread declined to 315 basis points (an ~51% swing both up and down within ~43 days). For investment-grade bonds (ICE BofA U.S. Corporate Index) for the same period, spreads went from ~90 basis points up to 120 basis points and back down to 93 basis points (still a 33% spike up and drop back in about a month and a half). Not surprisingly, these dramatic swings in pricing correlate precisely to the odds of a recession of the U.S. economy as well; by April 7th, consensus odds for a recession (U.S. Polymarket 2025 Recession Odds) surpassed 65% before declining to approximately 37% by mid-May.

Private Markets Show Unusual Stability

With all this noise in the general economy and heightened volatility in the traded exchanges, you would think there would be a corresponding unsettling in the private market, but that really never materialized. To the contrary, as a general proposition, pricing, leverage multiples, and general terms in May are nearly identical to where they were in January—and lest we not forget, pricing and terms in January were among the most aggressive and competitive they have been since 2007. As noted in our January Update, “It is hard to imagine a more favorable environment for financing middle-market issuers than the private market in Q1 2025. Credit spreads have compressed to their lowest levels in years, and leverage multiples for larger issuers have expanded to levels not seen since just before the Great Recession.”

Excess Liquidity, Limited Deal Flow

Importantly, the drivers for these “excess liquidity” conditions in May are literally identical to those in January, but simply more pronounced. The two most significant drivers are the magnitude of private credit “dry powder” (i.e., untapped capital available for deployment into new deals) and a dearth of “new money” deal flow (i.e., M&A transactions, LBOs, growth capital, and leveraged recapitalizations). As per Pitchbook, “Halfway through 2024, private debt dry powder sat at $566.8 billion—a new high—and is on track for its second consecutive year of growth. The dry powder is through June 30 due to late reporting from GPs and LPs. The asset class’s robust fundraising supported the growth over the past couple years. Despite the slight fundraising slowdown in 2024, dry powder’s ascent has not been affected as it has in other asset classes, such as PE. Moreover, dry powder’s share of AUM now sits at 31.1%, which aligns with each of the last two years.” In short, the “supply” side of the equation is robust; however, the “demand” side of the equation remains woefully below expectation.

A Perfect Storm for Private Equity

The Wall Street Journal recently published “Private Equity World Engulfed by Perfect Storm,” noting that “even before President Trump’s tariff chaos, buyout firms had been struggling to sell their portfolio companies and return money to anxious investors. Now recession fears and market turmoil have brought dealmaking to a near standstill.” As per data cited by Pitchbook, “Wild stock-market swings related to tariffs threaten to upend private equity’s plans to exit from investments as the industry sits on a backlog of more than 12,000 U.S. companies, including about 3,800 that have been held for five to 12 years… The year started relatively strong with an estimated 402 exits during the first quarter worth some $186.6 billion, up from 332 exits totaling $88.2 billion the same period a year earlier, but the preliminary data also show that while exit value has been increasing quarter on quarter, the number of exits in the first quarter declined from the fourth.” Until we see a meaningful uptick in PE exits and M&A activity in general, market conditions will continue to favor issuers as commercial banks, non-bank senior direct lenders, credit funds, SBICs, BDCs, and insurance companies all compete for a diminished supply of new money deal flow. Continued economic uncertainty only exacerbates the situation.

An Opportune Moment for Recapitalisations

There is one particular beneficiary of the current incongruity between capital and deal flow; specifically, equity sponsors that are seeking liquidity for their LPs yet are reluctant to exit and transact at current enterprise multiples. Timing is exceedingly opportune for leveraged recapitalizations. SPP’s ongoing outreach to lenders confirms a heightened interest in recaps, with pricing and terms historically reserved for accretive uses of capital (acquisitions and growth capital). That translates to pricing without the “premium” associated with a non-accretive use of capital, expanded leverage capacity, and increased “adjustments” to EBITDA for covenant compliance businesses. Investors will still scrutinize leverage as a percentage of enterprise value (i.e., the residual “LTV” or loan to value) as well as traditional underwriting considerations (size, sector, supplier/customer concentration, and cyclical vulnerabilities).

Conclusion: Issuers Still Have the Upper Hand

The takeaway this month is pretty straightforward; given the lack of overall transaction activity and an abundance of capital earmarked for deployment, with base rates and credit spreads remaining among their most competitive levels in the last five years, this is still very much an issuer’s market, and luckily, issuance conditions are not likely to deteriorate anytime soon. After all, “Nothing Changes Around Here.”

Minimum Equity Contribution

The level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders remain fixated on a minimum 50% LTV (i.e., equity capitalization of 50% of enterprise value), and actual new cash in a deal should also constitute at least 75% of the aggregate equity account. While lenders will certainly give credit to seller notes and rollover equity, the cash equity quantum continues to be an essential and primary underwriting consideration. The good news is that non-bank lenders, private credit funds, insurance companies, BDCs, and SBICs are all potential sources of equity capital as well as debt capital, and in many cases, are more than happy to shore up and backfill the equity account directly.

Equity Investment and Co-Investment

Liquidity for both direct equity investments and co-investments is robust in the new year, and in most cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Importantly, equity investment can take a variety of forms (preferred, common, warrants, even HoldCo notes) depending on the unique requirements of a given deal. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real “skin in the game” (i.e., a meaningful investment of their own above and beyond a roll-over of deal fees). While family offices remain the best source of straight common equity, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing combined debt and equity tranches.

Dividend Recapitalization Liquidity

Though continued volatility and a perceived credit down-cycle could inhibit and even terminate dividend recap activity, for the time being, the market remains dividend recap-friendly, especially where the recap is combined with a more accretive use of capital, such as an acquisition or specified growth capital initiative. As a general proposition, non-bank lenders are readily available to fund leveraged recaps, with leverage tolerances exceeding 4.5x LTM EBITDA for larger middle-market issuers (>$25 million of LTM EBITDA), while commercial banks remain reticent to fund recapitalization financings absent exceedingly low leverage (<2.0x LTM EBITDA) and LTV metrics (<30% TD/Enterprise Value) combined with a historical credit relationship.

Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

Private Market Paradox

Notwithstanding two of the most tumultuous weeks in capital markets history, SPP is not making any modifications to its leverage and pricing metrics guidance for the month of April. While these first couple of weeks of the month have seen literally trillions of dollars in value erased in the equity markets and an increase in bond yield levels not seen since the early stages of the Covid pandemic, private market liquidity conditions remain, at least for the time being, among their most competitive levels historically. Regardless of the larger issues of a global trade war, middle-market issuers retain most of the same market advantages and benefits they did in January, and for higher-quality credits (>$25 million in LTM EBITDA), potentially even better terms. What we term as the “private market paradox,” others simply see a literal “Ball of Confusion.”

Private Market Liquidity Holds—For Now

The traded capital markets (i.e., syndicated loans, public and 144A bonds) literally melted down in the last week before recovering on April 9th upon the announcement by the White House of a temporary reversal of “reciprocal tariffs.” Prior to the announcement, corporate bond spreads widened for eight consecutive trading sessions in a row. Yield premiums on a Bloomberg index of investment-grade corporate bonds rose to 90 basis points on April 4th, wiping out all the tightening that took place previously for the year. That move cemented the index’s longest streak of widening spreads since October 2023, according to data compiled by Bloomberg. The fallout for below-investment-grade bonds was more marked, where U.S. high-yield spreads broke a two-year trend downward and jumped from a spread of ~300 basis points over UST to over 450 basis points over UST. U.S. Treasuries were not immune either; as Kenny Polcari summarized the volatility, “The benchmark 10 yr U.S. Treasury collapsed causing yields to spike, reaching a high of 4.51% before retreating to end the day at 4.32%. This followed a volatile week where yields had already climbed from a low of 3.85%. The 2-yr yield hit 4.01% after yielding 3.47% last week. …all while the 30-yr hit 5.02%, a level not seen since November 2023, before easing slightly to end the day at 4.73%.” Unlike the hourly fluctuations in the traded capital markets however, private market liquidity conditions move glacially and remain for the most part static; the overwhelming majority of debt and equity security purchasers in the private market are “buy and hold” investors the concept of trading out of an asset or seeking secondary liquidity for the most part, simply doesn’t exist. It’s the primary reason lenders spend the time and effort of crafting bespoke covenant structures for every unique opportunity.

The Key Driver: Lack of “New Money” Deal Flow

The single greatest driver for the current “excess liquidity” conditions in the private market has been lack of deal flow, and more specifically, the lack of “new money” deal flow (i.e., capital raised for acquisitions, LBOs, recaps, and other growth initiatives—excluding refinancing and repricings). As reported by Bloomberg, “At just $35.9b or 11% of volume in Q1 2025, new money financing remains sluggish amid record levels of issuance. At $339.2b, first quarter issuance was among the busiest since Bloomberg began tracking the data in 2013, however that did not translate into the M&A spree many were hoping for. Instead, since the start of 2024 repricings have commanded a whopping 70% of deal flow at the expense of new money issuance, which over the same time has made up just 10% of US institutional leveraged loan volume and falls well below the five-year average of 31%.”

Given the heightened level of uncertainty around tariffs and the adverse implications of a prolonged trade war, it is unlikely that the long-awaited revival of M&A activity will happen anytime soon. To the contrary, as the first two weeks of April suggest, it is becoming increasingly possible that the proposed U.S. tariff scheme and pending trade war will push inflation up and drive economic activity down, and ultimately, the private market will not be immune. In short, liquidity conditions will suffer. This played out during the Great Recession and again during the pandemic. Even before the so-called “tariff tantrums” began, there already were warning lights burning red for the economy; bankruptcy filings have been on a steady upward rise beginning in January of 2025, and distressed debt levels are at their highest levels since October of 2024. Though predictions of a 2025 recession have moderated since the announcement of the 90-day tariff pause, they are still elevated. After the President’s announcement, Goldman economists still maintain a 45% probability of a recession in 2025. “We are reverting to our previous non-recession baseline forecast with GDP growth of 0.5% and a 45% probability of recession,” a group of researchers led by Jan Hatzius wrote in a report. Roughly an hour earlier, the same researchers had said that they forecast a GDP loss of 1% this year and a 65% probability of the economy entering a recession in the next twelve months.

Why Issuer Strategy Matters More Than Ever

If credit conditions do in fact continue to deteriorate, lenders in the private market will revert to a more defensive “down-cycle” underwriting strategy (i.e., the underwriting equivalent of “circling the wagons”). To no one’s surprise, that translates, quantitatively, to higher spreads and lower leverage multiples (pretty much erasing the spread compression and leverage multiple expansion of the last year), and the re-emergence of SOFR floors (in response to the expectation that the Fed will likely have to cut rates to boost liquidity). Qualitatively, that translates to expanded diligence and attenuated timetables (“waiting for the shoe to drop”) and increased barriers to entry for lower middle market, cyclical, and “storied” issuers, and in particular, issuers with material exposure in their supply chain to international procurement.

However, there are critical steps potential issuers can take to insulate themselves from the impact of a down credit market and a less hospitable issuance ecosystem.

• First and foremost, in the same way lenders have increased scrutiny for issuers during economic volatility, issuers should have heightened awareness to have the right credit partner. Lenders that have trouble in their portfolio, or that are publicly traded and experiencing liquidity constraints due to share price reductions, simply may not have the capacity to be flexible and constructive in a down cycle.
• Enhanced issuance strategies should be employed; issuers should have a broad and comprehensive offering to capture every potential lender that can offer the most aggressive terms available in the market. Offering materials must also be comprehensive and detailed to specifically address heightened underwriting scrutiny, with a sophisticated (again, comprehensive and detailed) financing model, with thoughtful operating forecasts for setting adequate covenant compliance levels.

While most sponsors have their list of “go to” lenders for a given opportunity, and legacy credit relationships are a staple of the private market, the overwhelming majority of sponsors and issuers simply don’t have the frequency and magnitude of deal flow to really exploit the myriads of competing pools of capital available in 2025, and especially so in a tighter credit environment. To put it in perspective, since 2011 (when SPP started tracking this data and publishing the Market Update), SPP has averaged a 5.0x oversubscription per financing. We do this by assuring our issuers enhanced access to the $1.5 trillion pool of private capital competing for assets and using the most effective, empirically-based offering strategies available. As so brilliantly exposed over the course of the last few weeks, this market is the epitome of a “Ball of Confusion”; having the right partner (whether a bank, non-bank direct lender, credit fund, or placement agent that provides access to all of them) is crucial to successfully navigating it.

Tone of the Market

Private market liquidity conditions can best be described as a period of stasis in April (i.e., “a state of static balance, equilibrium, or inactivity, where something remains unchanged or stagnant”). Market dynamics started the year on a very optimistic note; base rates were about 100 basis points below where they were a year earlier, credit spreads had compressed by approximately 50 to 150 basis points, key macroeconomic metrics were positive, and all indications were that M&A activity, long dormant, was poised for a robust and precipitous revival. Importantly, private market lenders were sitting on unprecedented levels of dry powder eager to deploy with pricing and terms as aggressive as they have been since 2007. Since then, threats of a trade war have escalated, more than ~$5 trillion in value has been erased in the stock market and credit spreads in the traded syndicated loan, 144A and public bond markets have reverted to levels last seen in mid-2023. One of the great attributes of the private market, however, is its resilience. Notwithstanding the magnitude of volatility felt in the traded markets, private market liquidity conditions remain stubbornly issuer-friendly, and while the “risk-on” and “go-go” euphoria that characterized Q1 is gone, lenders are not revising their underwriting criteria, hiking spreads, or cutting leverage tolerances…yet. Nevertheless, uncertainty is rampant, keeping prospective acquisitions, capital expenditure, and growth initiatives on a back burner. Interestingly, something of a private market paradox is forming; while more efficiently traded markets are experiencing heightened volatility and deteriorating issuance metrics, the lack of deal flow in the private market is keeping already financing-deprived banks and direct lenders with continued competitive terms and, in some cases, improving market metrics. This paradox will be short-lived however; if the current trade standoff leads to higher inflation and a recession, the private market will most certainly correct as well.

Minimum Equity Contribution

The level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders remain fixated on a minimum 50% LTV (i.e., equity capitalization of 50% of enterprise value), and actual new cash in a deal should also constitute at least 75% of the aggregate equity account. While lenders will certainly give credit to seller notes and rollover equity, the cash equity quantum continues to be an essential and primary underwriting consideration. The good news is that non-bank lenders, private credit funds, insurance companies, BDCs, and SBICs are all potential sources of equity capital as well as debt capital, and in many cases, are more than happy to shore up and backfill the equity account directly.

Equity Investment and Co-Investment

Liquidity for both direct equity investments and co-investments is robust in the new year, and in most cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Importantly, equity investment can take a variety of forms (preferred, common, warrants, even HoldCo notes) depending on the unique requirements of a given deal. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real “skin in the game” (i.e., a meaningful investment of their own above and beyond a roll-over of deal fees). While family offices remain the best source of straight common equity, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing combined debt and equity tranches.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

M&A Activity Falls Short of Expectations

SPP is not making any changes to its pricing and leverage metrics for the month of March, but potential issuers should not necessarily assume that the current borrower-friendly, “risk-on” liquidity conditions in the private market will remain static into the spring, for as Bob Dylan aptly predicted in the fall of 1963, “The Times They Are A-Changin’,” and unfortunately, not necessarily for the better.

When Donald Trump was elected, investors thought his deregulation agenda would help bring back M&A dealmaking, exits, and distributions. Contrary to expectation, however, deal flow into the third month of the year remains lackluster; the “tidal wave” or “deluge” (or whatever is your preferred terminology) of new M&A activity has simply not materialized. In fact, private market M&A activity has only diminished in 2025—by a factor of 30% compared to the same time last year. As noted in LSEG, “Amid the whiplash of ‘will they or won’t they’ come into effect, talk of tariffs have contributed to the slowest start to the U.S. M&A calendar in ten years. Despite market hopes that the new administration would ease regulatory pressures to support a meaningful increase in acquisition deals during 2025, the return of market volatility and recession fears has contributed to a slowdown in announced M&A deals—at least for now. So far this year, 1,873 M&A deals have been announced in the U.S., a drop of over 30% compared to the same time last year.”

The Supply and Demand Imbalance in Private Markets

That lack of new money deals (i.e., proceeds for that add net-new issuance to the market, such as acquisition financing, capital expansion, and dividend recaps) serves only to perpetuate a supply/demand imbalance overwhelmingly in favor of issuers. Institutional lenders need to deploy capital, but the pace of new money deal flow remains languid, and the majority of financing activity that is reported is for refinancing and repricing. As reported by @markets, “Repricings have surged to dominate leveraged loan issuance, vastly outpacing new money deals and refinancings. This trend accelerated sharply in early 2024 and continues into 2025, driven by borrowers adjusting loan terms amid strong demand and tightening spreads.” In short, there is no underlying macroeconomic influence driving more competitive conditions in the private market, but rather a deficit in deal flow, especially new money deal flow.

Importantly, current “excess-liquidity” conditions could turn quickly; there is increasing evidence of a potential credit “down-cycle” in the works, which could have a materially adverse impact on pricing, leverage capacity, and, for some, even access to capital itself. As per data from S&P Global Market Intelligence, U.S. corporate bankruptcy filings reached a 14-year high in 2024 (694 filings in 2024 marked the highest number of such filings since 2010). Recent data from Fitch suggests private market default exposure is increasing as well. “The default rate in Fitch Ratings’ portfolio of U.S. privately monitored ratings (PMR) rose sharply to 8.1% in 2024. This is the highest level since Fitch recorded the first default in the portfolio in 2019.”

The inflationary impact of tariffs, a prolonged trade war, and even talk of recession is already having a profound impact on other, more traded markets. Corporate credit default swap spreads (i.e., the annual premium, expressed as a percentage of the notional amount, that the protection buyer pays the protection seller for insuring against the risk of default of a specific debt obligation) have spiked recently, reflecting an increasing level of investor angst. Not surprisingly, underlying corporate credit spreads in the traded bond markets have widened sharply in recent weeks as well.

Impact on Middle and Lower Middle Market Issuers

Short-term volatility in the public, 144A, and syndicated loan markets is not determinative of liquidity conditions in the private capital markets, especially with respect to the mid-middle market ($20+ million of LTM EBITDA) and lower middle market (sub-$10 million of LTM EBITDA) issuers. However, should the recent increasingly negative macroeconomic indicators (the Atlanta Fed’s GDPNow predicting GDP contraction of -1.8% and the University of Michigan’s Consumer Confidence in March declining to 57.9, the lowest level since 2022) be a sign of what is to come, the private market will be ultimately be affected with access to capital impaired (i.e., higher credit spreads, lower leverage multiples, and tighter covenant restrictions (including adjustments to EBITDA), less market receptivity to non-accretive uses of capital (i.e., recaps and share repurchases), and greater barriers to entry for issuers in highly cyclical sectors, the lower middle market, and “storied” credits.

Looking Ahead: Opportunities Amid Change

While liquidity remains favorable today, issuers have a valuable opportunity to secure capital under current market conditions. Staying proactive and prepared will be key as the market evolves — after all, “The Times They Are A-Changin’.”

Again, as of this writing, private market liquidity conditions remain optimal; but, for the first time in two years, the foundation upon which this liquidity sits is more fragile, and to many a signal that “The Times They Are A-Changin’.”

Tone of the Market

The long-awaited “tidal wave” of M&A deal activity still has not materialized, keeping the supply/demand advantage firmly in favor of issuers. Pricing and leverage metrics remain static for the time being, still hovering among their most competitive levels historically. However, increasing macroeconomic uncertainty surrounding tariffs (i.e., trade wars, inflation, and even recession) has lenders rethinking their underwriting parameters and increasingly contemplating a more defensive credit positioning for a potential “down-cycle.” Should these fears play out, the potential adverse effects on new issuance will be dramatic and have an even more chilling impact on M&A activity. As we have seen play out in the private market during the Great Recession and Covid era, as banks and institutional lenders circle the wagons, lower middle market, storied, and more challenged credits will be disproportionately adversely impacted, recapitalization and other “non-accretive” uses of capital will be discouraged, and leverage multiples will contract while credit spreads widen. Less leverage capacity and higher costs of capital will diminish enterprise values, further deteriorating whatever nascent M&A activity currently exists. That, of course, is a worst-case scenario, and the current market consensus is that less draconian credit conditions will emerge as the underlying strength of the economy (moderate inflation, low unemployment, and continued growth in GDP) combined with a more tempered trade policy diminishes current market volatility.

Minimum Equity Contribution

The level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders remain fixated on a minimum 50% LTV (i.e., equity capitalization of 50% of enterprise value), and actual new cash in a deal should also constitute at least 75% of the aggregate equity account. While lenders will certainly give credit to seller notes and rollover equity, the cash equity quantum continues to be an essential and primary underwriting consideration. The good news is that non-bank lenders, private credit funds, insurance companies, BDCs, and SBICs are all potential sources of equity capital as well as debt capital, and in many cases, are more than happy to shore up and backfill the equity account directly.

Equity Investment and Co-Investment

Liquidity for both direct equity investments and co-investments is robust in the new year, and in most cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Importantly, equity investment can take a variety of forms (preferred, common, warrants, even HoldCo notes) depending on the unique requirements of a given deal. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real “skin in the game” (i.e., a meaningful investment of their own above and beyond a roll-over of deal fees). While family offices remain the best source of straight common equity, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing combined debt and equity tranches.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

Middle Market M&A: Slow Now, but Poised to Rebound

As noted earlier, SPP is not making any modifications to its pricing and leverage metrics for February; credit spreads and leverage multiples remain at levels among the most competitive since SPP started tracking such metrics in 2011. As confirmed by SPP’s weekly outreach to institutional private market participants, the most significant driver for the fierce competition for assets remains “the lack of quality actionabl opportunities,” and the “unprecedented level of capital available” for deployment in 2025. As discussed in greater detail below, though M&A-based financing activity is beginning to pick up for upper middle market transactions (issuers with >$50 million of LTM EBITDA), the number of new money LBO opportunities for mid-lower middle market issuers remains depressed, and lenders are becoming increasingly creative to attract what limited deal flow does exist. It is widely anticipated, however, that middle market M&A activity will gain steam through a variety of factors, including lower base rates (SOFR at ~4.3%), tighter credit spreads, resulting higher enterprise valuations, sponsors’ need to return LP capital, increasingly optimistic expectations for macroeconomic growth, and more permissive regulatory environments all which conspire to break the “logjam” of middle market M&A deal activity. Better stated, the middle market is anxiously “Waiting On the World to Change.”

Debt Market Conditions Remain Extremely Favorable

There is no dearth of data supporting the proposition that issuance conditions for the debt markets are optimal. Pricing on leveraged loans, investment grade, high yield, and 144A bonds (i.e., credit spread over base rate SOFR or UST) are among their most competitive levels historically. As noted by Wall St. Jesus, “Credit Spreads are close to modern day tights and at levels last seen in 1997-1998.” Price compression has also impacted unitranche pricing, a relatively new addition to tracked leverage data. LSGEG LPC, recently reported that “unitranche pricing tightened significantly over the course of 2024, moving steadily lower in the first nine months of the year before edging higher in 4Q24. The unitranche blended spread averaged 539bp in 4Q24, up marginally from 533bp in 3Q24 but well below the 604bp recorded in 4Q23. Looking at the different market segments, the average unitranche spread for large corporate issuers tightened to 519bp in 4Q24, down from 599bp a year earlier. In comparison, middle market issuers saw unitranche spreads drop by 62bp year-over-year to 544bp in 4Q24.”

Though pricing is usually the first metric that is top of mind in assessing how competitive the market is, leverage multiples (i.e., aggregate debt capacity) are usually second, and again, current market leverage metrics for middle market issuers don’t disappoint; as reported by LSEG LPC, “…average total leverage of 4.70x in 4Q24 was above the 4.52x recorded at the same time last year. Leverage increased and spreads declined across company size in 2024. … leverage widened by 0.14x to 4.77x. In the lower middle market (EBITDA

Merely being aggressive in pricing and leverage capacity doesn’t necessarily translate into increased deal flow however, and increasingly lenders are resorting to expedited underwriting and diligence to attract assets. Whitehorse Capital recently published their “2025 Lending Outlook,” featuring an interview with Stuart Aronson, executive managing director and CEO of Whitehorse U.S., and Pankaj Gupta, president of Whitehorse U.S., where they discussed the new trend in such “diligent-lite” strategies. Gupta noted that, “Unfortunately, I think as lenders, we saw a gradual relaxation of those underwriting standards. And really, it depends on what part of the market we’re talking about. If you’re thinking about sponsored transactions, private equity-led LBOs for middle, upper middle market companies, given the relatively benign economic environment that we experienced in ’24 and what we’re experiencing right now with the outlook as it is right now, people have gotten pretty aggressive. People are competing to win business and the way they’re competing to win business is by relaxing their underwriting standards, doing something that we call “diligence-light”, which is effectively desktop-level diligence done in a few days to a week. And that has become more and more accepted in the upper middle market sponsor space”.

In addition to “diligent-lite” underwriting, issuers are increasingly also able to secure “covenant-lite” structures. Gupta noted, “Covenant light, I’m sure everyone knows, has crept into the middle market where companies now with typically $50 million or more of EBITDA are candidates for covenant light deals. And sometimes in certain situations we’ve even seen that go below $50 million. So that weakens the protections for lenders.” It doesn’t end with specific covenant levels either; as Gupta continued, “the other thing in that part of the market is, again, regardless of where the covenant is set, the underlying definitions that people are using for EBITDA in that market allow for pretty aggressive adjustments. And so with the stroke of a pen of a CFO, they could furnish a compliance certificate, which allows for unlimited add-backs to the EBITDA or prospective add-backs for revenue synergies and/or cost savings that are on the covenant that haven’t been actioned, or customers haven’t been won or whatever it is.”
As noted in this publication and others on countless occasions, the lack of new M&A deal activity is one of the primary causes of the “excess liquidity” conditions in the private capital middle markets described above. The good news is that it may be beginning to change; there is an increasing quantum of data suggesting M&A activity may be picking up. According to Pitchbook, in January, M&A-related leveraged loan volume jumped to its highest level in three years; having said that, it also should be noted that the new money for LBO purposes only accounted for $8 billion of a total of $186 billion of total institutional leveraged loan issuance for January, or ~4.3% of total issuance. Still, at $8 billion, the January M&A leverage loan activity was almost double the $4.1 billion recorded in January of 2024. At $146.9 billion (79% of monthly volume), repricings continued to account for the clear majority of leveraged loan issuance.

Signs of M&A Rebound Are Emerging

According to its latest M&A report, Bain & Company is “optimistic” for the year ahead in M&A. One reason for the optimism is how “companies have pursued M&A despite three years of headwinds, including high interest rates and regulatory scrutiny.” As noted by Maria Dikeos of LSEG, “New year, new administration, and improving U.S. economic outlook have combined to bring a much-needed boost to market psyche when it comes to hopes for new money deal flow in 2025.” Respondents to LSEG LPC’s Q1 2025 outlook survey are especially optimistic about M&A prospects. Among leveraged lenders, a whopping 63% of survey respondents note that momentum for more M&A/LBO deal flow is expected to build in 2025, up from 22% who felt this way heading into Q4 2024. An additional 13% believe that there will be significant upticks, up from 11%.

Private Equity’s Pressure to Return Capital May Drive More Deal Flow

One major driver often cited for expectations of increased M&A activity is the need for middle-market equity sponsors to return capital to LPs—either by harvesting portfolio companies or undertaking leveraged recapitalization financings. According to Pitchbook’s latest U.S. Market Insights report, the holding period of U.S. buyout-backed company inventory has risen to a median of 3.4 years in 2024, the longest period on record since 2015, and a ~10.2% increase over 2023. Drilling down further, in 2024, ~18.4% have been held 5 to 7 years, and ~13.2% have been held for more than 7 years (up from 17.5% and 9.1%, respectively, in 2023).

In short, 2025 is “expectation rich”—fueled by macroeconomic, political, and regulatory optimism, unprecedented private market liquidity, and a release of pent-up demand by sponsors to both deploy new capital and return LP investment via M&A/Recap financing; i.e., “Waiting On the World to Change.”

Tone of the Market

SPP has not made any changes to pricing or leverage metrics for February; liquidity conditions, for all practical purposes, are virtually identical to January. Having said that, it must be noted that January metrics were among the most aggressive we have published in the last five years. Deal flow, especially middle market M&A-based transaction activity, remains subdued, and resultingly, competition for new assets is fierce. Lenders across the credit spectrum complain about the lack of “quality” actionable opportunities. January saw an uptick in the larger leveraged loan M&A market, which historically correlates to a subsequent increase in middle market M&A-driven activity. For the time being, however, this is clearly an issuer’s market characterized by unprecedented competitive pricing, expanded leverage capacity, streamlined underwriting (from diligence through documentation), flexible covenant structures, and expansive “adjustments” to EBITDA. While concerns remain respecting the inflationary impact of tariffs and the removal of foreign laborers, underlying macroeconomic strength continues seemingly unabated. As a general proposition, market participants expect current “surplus liquidity” conditions to persevere through the second quarter.

Minimum Equity Contribution

The level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders remain fixated on a minimum 50% LTV (i.e., equity capitalization of 50% of enterprise value), and actual new cash in a deal should also constitute at least 75% of the aggregate equity account. While lenders will certainly give credit to seller notes and rollover equity, the cash equity quantum continues to be an essential and primary underwriting consideration. The good news is that non-bank lenders, private credit funds, insurance companies, BDCs, and SBICs are all potential sources of equity capital as well as debt capital, and in many cases, are more than happy to shore up and backfill the equity account directly.

Equity Investment and Co-Investment

Liquidity for both direct equity investments and co-investments is robust in the new year, and in most cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Importantly, equity investment can take a variety of forms (preferred, common, warrants, even HoldCo notes) depending on the unique requirements of a given deal. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real “skin in the game” (i.e., a meaningful investment of their own above and beyond a roll-over of deal fees). While family offices remain the best source of straight common equity, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing combined debt and equity tranches.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

[email protected]
Ph: +1 212 455 4502

Competitive Pricing and Strong Liquidity

Coming into the holiday season, SPP is not making any changes to its pricing or leverage metrics. Credit spreads and leverage multiples remain at their most competitive levels of the year, and with middle-market M&A deal flow still relatively anemic, it is more than likely that current liquidity conditions will persist into the new year.

Though the magnitude and frequency are still subject to debate, it is widely anticipated that the Fed will continue its current path of quantitative easing. The Fed Funds rate has already been slashed by 75 basis points to a rate band of 4.50%–4.75%, resulting in a current SOFR rate of ~4.60%. Stated more succinctly, current liquidity conditions are “Strong Enough.”

Private Markets Lag but Follow Public Market Trends

Private market pricing and leverage metrics historically lag behind those of the more liquid public and 144A markets. If current traded conditions are any indication of future private market liquidity, pricing for the time being will remain exceedingly aggressive. The average spread for investment-grade bonds has fallen to its lowest level since 1997, while high-yield spreads remain at their tightest levels since the Great Recession in 2008.

Though Goldman predicts spreads will widen marginally by year-end (~13bp higher for investment-grade bonds and ~14bp for high yield), from a historical perspective, the public and 144A markets are trading at incredibly competitive levels. This suggests that private market spreads will likely follow suit in the short term.

To better illustrate current liquidity conditions, let’s look at actual deals executed by SPP in 2024. In March of 2024, a typical middle-market company (e.g., ~$15 million of LTM EBITDA, reasonable total leverage of ~3.75x, non-cyclical sector with well-regarded equity sponsorship) would garner non-bank unitranche pricing of SOFR + 6.50% for an all-in cost of ~11.80% (SOFR @ March 15 ~5.30% + credit spread of 6.50%).

Today, a nearly identical issuer will likely garner a spread of SOFR + 5.5% for an all-in rate of ~10.10% (SOFR @ November 15th at 4.60% + credit spread of 5.50%), i.e., a savings of ~170 basis points. Lower-cost capital translates to higher fixed-charge coverage and, accordingly, greater leverage capacity.

Leverage Metrics: On the Rise Across Middle-Market Deals

Recent empirical data published by LSEG supports this analysis. According to a study published by LSEG, total leverage on sponsored middle-market deals climbed to 4.76x on average in Q3 2024 from 4.61x in Q2 2024, the highest quarterly level recorded since Q1 2022.

As per LSEG, “The increase was driven by both higher senior and junior leverage. First-lien leverage came in at 4.47x in Q3 2024, up from 4.41x in Q2 2024, while junior leverage increased to 0.29x from 0.20x. Looking deeper into this metric, the share of deals with total leverage above 5x climbed to 40% in Q3 2024 from 34% in the prior quarter. At the higher end, the share of deals levered more than 6x ticked up to 13% from 10% in Q2 2024.”

M&A Activity: The Elusive Surge

Notwithstanding the fact that leverage and pricing metrics are among their most competitive levels in years, the much-anticipated “surge” of M&A activity has yet to materialize. Recent data suggests that M&A activity has become increasingly moribund.

Hold periods on private equity (the period between acquisition and exit) have only increased in recent years. As reported in Pitchbook, the median exit hold period and average existing hold period have increased to 6.4 years and 5.3 years, respectively, up from 5.1 years and 4.9 years in 2021.

Refinancing Boom: A Record Year for Leveraged Loans

Leveraged loan activity is not driven by M&A activity but rather by repricing and refinancing. U.S. leveraged loan sales hit a record $986 billion in 2024, surpassing 2017 as the busiest year on record. As reported by Bloomberg, most of this year’s volume came from companies refinancing their current credit agreements and/or locking in lower margins through repricing.

In short, though deal flow has been robust, it has not been accretive. As highlighted by Bloomberg, “The type of deals getting done underscores a painful market dynamic for investors: too much leveraged loan demand and not enough supply of new debt for uses like buyout financing.”

Looking Ahead: The 2025 M&A Breakthrough

Ultimately, we expect the M&A logjam to break open in 2025. A confluence of factors—lower base rates, tighter credit spreads, enhanced leverage capacity (translating to higher enterprise multiples), the need to return capital to LPs, and a likely merger-friendly regulatory environment—will provide a strong incentive to trade. In our view, this environment will be more than “Strong Enough.”

Tone of the Market

Credit spread and leverage multiples in the private market will end 2024 at their most competitive levels of the year, a product of: (i) lighter than average middle market deal flow; (ii) under-invested funds with unprecedented levels of dry powder, still seeking to lock in assets prior to year-end; (iii) increased confidence in a robust and growing macroeconomic environment; and (iv) enhanced optimism for a more forgiving and potentially less restrictive regulatory ecosystem with the advent of a new administration. While Fed interest rate reductions (the Fed funds rate band now sits at 4.50% – 4.75%) have spurred a slight uptick in corporate issuance, the much-anticipated increase in M&A activity has yet to materialize, only increasing the pressure on investors to drive more competitive terms. Market participants remain optimistic that the first half of 2025 will be characterized by an unprecedented surge in M&A-driven transaction activity, which could have a materially adverse impact on pricing and terms, especially in the event of any reversal in recent economic trends or heightened expectation of geopolitical instability.

Equity Investment and Co-Investment

Notwithstanding otherwise aggressive metrics across the market, the level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders are focused on a minimum 50% LTV (i.e., equity capitalization of 50%). More importantly, actual new cash in a deal should also constitute at least 75% of the aggregate equity account. Most lenders remain reticent to provide aggregate leverage in excess of 4.0x LTM EBITDA with only 20% to 25% new cash equity. While lenders will certainly give credit to seller notes and rollover equity, the new cash equity quantum continues to be an essential and primary underwriting consideration.

Recapitalization Liquidity

The market remains exceedingly recap-friendly, especially where the recap is combined with a more accretive use of capital, such as an acquisition or specified growth capital initiative. While commercial banks remain reticent to fund recapitalization financings absent exceedingly low leverage (<2.0x LTM EBITDA) and LTV metrics (<30% TD/Enterprise Value) combined with a historical credit relationship, non-bank lenders have little or no reluctance to fund leveraged recaps, with leverage tolerances exceeding 4.5x LTM EBITDA for larger middle market issuers (>$20 million of LTM EBITDA). Leveraged recap activity reached its highest level in the first quarter of 2024 since Q1 of 2021.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

The Calm Before the Storm

Last month’s “State of the Private Market” was entitled “About to Get Crazy,” reflecting our belief that the Fed’s decision to lower interest rates (the Fed Funds Rate range was lowered from 5.25%-5.50% to 4.75%-5.00%) was going to drive a deluge of new deal flow into the traditional private placement market. The long-awaited reduction in rates would spur companies to refinance at lower rates, undertake deferred capital projects, and most significantly, unlock a wave of M&A activity (i.e., lower rates translate to greater debt capacity, which translates to higher enterprise multiples, which drives exit activity). On top of all this, it was taking place in the last quarter of the calendar year, traditionally the most active season in the private market for deal-making. If anything, I expected that for our October Update I would be increasing credit spreads reflecting the increased demand for capital against a finite amount of capital and resources. Instead, SPP is lowering credit spread metrics across the credit spectrum by a factor of 25 to 50 basis points. That is just “Strange.”

Interest Rate Shift Sparks Optimism for Private Placement Markets

More specifically, SPP is lowering its credit spread metrics by approximately 50 basis points for senior non-bank direct lending and by 25 to 50 basis points for unitranche and second lien financing. The move comes in response to the private market’s need to attract deal flow; institutional private credit providers remain starved for quality deal flow and come into Q4 of 2024 palpably underinvested for the year. SPP’s anecdotal data, based on our continued canvassing of more than 120 middle market commercial banks, non-bank direct lenders, and private credit funds, shows that deal flow is approximately 75% of what it was a year ago. Our data is consistent with recently published data by LSEG; according to LSEG LPC’s 4Q24 Middle Market Outlook Survey, most middle market lenders found “insufficient” deal flow for Q324. “A majority of respondents (63%) said they were not able to lend as much as they wanted in 3Q24. This was particularly the case for banks, with 83% of them not lending as much as they wanted. In comparison, the responses from direct lenders were more mixed, with just over half (52%) not able to lend as much as they desired”.

Unexpected Tightening in Credit Spreads

A tightening in credit spreads is not unique to private middle market lenders. Almost every major credit constituency (public, private, 144A, and syndicated loans) has experienced enhanced liquidity, evidenced by tighter credit spreads in recent weeks; investment grade spreads have tightened 50 to 100 basis points, and high yields by 100 to 150 basis points. However, the similarities between the more parochial, illiquid private middle market and the more efficient, larger “traded” markets end there. While private market deal activity remains suppressed, deal flow in the traded markets has literally exploded in the last month.

As reported by Kelly Thompson of KBRA Direct Lending Deals (“KBRA DLD”), private “jumbo loan” (loans whose aggregate principal amount exceeds $1 billion) volume has increased dramatically in recent months. “Private jumbo loan volume stands at a record totaling $69.7 billion through Sept. 18. The total tops full-year volume of $50.3 billion in 2023, and the previous high of $59.2 billion recorded in 2022. Final 3Q24 numbers are pending but indicate YTD volume will be closer to $80 billion. At the current pace, full-year volume is on track to finish at roughly $100 billion, assuming 4Q24 volume can match 4Q23.” We have also seen a massive leap in deal flow in the U.S. broadly syndicated loan market. As reported by LSEG LPC, “The U.S. broadly syndicated loan market supported over US$110.5bn of acquisition financing in 3Q24, the strongest quarterly results in over two years, pushing 1-3Q24 totals to nearly US$266bn. Issuance for the first nine months was up 35% year over year.”

Current Challenges in Private Market Deal Flow

The big question remains as to why deal flow in the private middle market still lags compared to its larger traded peers. Historically, at least, private market activity tends to move slower than the more efficient traded markets. For one thing, private lenders are traditionally “buy & hold” investors, creating the need to have more detailed, unique, and restrictive covenant schemes (as a general proposition, lenders cannot simply “trade out” of a loan gone south); thus, deal processes themselves tend to be more protracted and lengthier. However, SPP’s anecdotal investor surveys suggest the real reason behind the slower deal calendar in the private market is that the much-anticipated increase in M&A has simply not materialized… yet.

This trend is supported by recent data published by PitchBook, which suggests GPs are not rushing to the market yet to sell off assets, even in light of the current lower interest rate/higher enterprise value model. M&A deal activity has declined globally each year since 2021, when the value of M&A transactions reached an eight-year peak of $4.7 trillion, according to PitchBook. The total fell to $3 trillion last year and at $1.46 trillion this year through June is on track for a further decline. According to PitchBook, “GPs that have held out for better exit conditions stretched out the median holding period of PE investments, which reached a record of 6.4 years for U.S. PE middle-market assets in 2023. GPs have alleviated some of the pressure mounting from a backlog of exits, rolling back the median holding period to 5.4 years for assets that have exited this year so far. The same trend can be seen in the broader PE market as well. Still, the exit/investment ratio fell to 0.36x in Q2, a new low that reflects the beleaguered state of exits. Thus, we can assume that GPs are bringing their highest-quality assets to market to secure favorable exits while holding off on the rest of their portfolios. We expect holding periods of PE backed exits to remain drawn out until the exit environment improves meaningfully.”

Lingering Uncertainty and Projections for M&A Recovery

While deal activity in the traditional private middle market remains lethargic, there is still a widespread consensus that deal activity will pick up, and the uptick should be substantial. “As [the] cost of capital comes down, you’ll see an increase in transaction volume, and the most direct beneficiary of that increase in transaction volume will be direct lending because a lot of the activity in that market is M&A driven,” said Michael Zawadzki, the global chief investment officer for Blackstone’s credit and insurance team.

Q4 2024: The Most Favorable Liquidity Conditions for Middle Market Issuers in Years?

So, taking stock of current conditions, middle market issuers currently have about the best possible liquidity conditions for issuance they have had in years. Base SOFR rates are lower and expected to drop further, credit spreads have tightened (and absent a flood of new deal activity in the coming weeks, may even continue to compress), and private market lenders are markedly underinvested for 2024. Rather than Q4 being the least hospitable environment for new financing, in 2024, Q4 may in fact be optimal for issuance. “Strange.”

Tone of the Market

All indications are the liquidity conditions are optimal for issuance in Q4 of 2024; (i) SOFR rates have declined to ~4.90%, down about 40 basis points since the Fed lowered the Fed Funds rate at its September FOMC meeting; (ii) credit spreads for mid-upper middle market issuers have compressed by approximately 25-50 basis points; and (iii) the majority of private credit portfolios remain underinvested for the year. Strangely, however, new deal activity in the private market is stunningly anemic. The predictions for a dam-busting deluge of new M&A activity this fall have simply not materialized, and even the traditional Q4 surge of deals set to close by year-end lags behind prior periods.

Historically, the fourth quarter is a less hospitable issuance environment for middle market issuers, as larger, better capitalized issuers dominate the new deal calendar, but 2024 may prove to be the exception. Even lower and mid-middle market issuers will benefit from tighter spreads, enhanced leverage capacity, and increased receptivity to non-accretive uses of capital such as leveraged recapitalization financings. However, the lack of uptick in activity may prove to be more of a timing issue than anything else. Larger corporations, “jumbo” issuers, widely syndicated deals, and the publicly traded markets have all experienced record amounts of new deal flow; the traditional private capital middle markets, we believe, are simply lagging behind the more efficient traded markets.

Minimum Equity Contribution

Notwithstanding otherwise aggressive metrics across the market, the level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders are focused on a minimum 50% LTV (i.e., equity capitalization of 50%). More importantly, actual new cash in a deal should also constitute at least 75% of the aggregate equity account. Most lenders remain reticent to provide aggregate leverage in excess of 4.0x LTM EBITDA with only 20% to 25% new cash equity. While lenders will certainly give credit to seller notes and rollover equity, the new cash equity quantum continues to be an essential and primary underwriting consideration.

Equity Investment and Co-Investment

Liquidity for both direct equity investments and co-investments continues to be robust in the new year, and in many cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real skin in the game (i.e., a significant investment of their own above and beyond a roll-over of deal fees). Family offices remain the best source of straight common equity, and, continuing the trend established in 2020, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing both debt and equity tranches.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

M&A Activity in 2024: A Slow Start, But Change Is Coming

In a year punctuated by one major geopolitical or macroeconomic report after another, one consistent theme has been the relative lackluster deal flow in the U.S. private capital markets. The majority of deal flow in 2024 has been comprised primarily of repricing and refinancing activity, as M&A deal activity has continued to languish in the first half of the year. The global value of M&A activity in the first half of 2024 was ~$1.0 trillion. Although this figure is 4% higher than that of the same period last year, it is below the ten-year average of $1.5 trillion. That may be beginning to change; expectations for a post-Labor Day rebound in capital market activity are so rampant that market participants report it’s “About To Get Crazy!”

Post-Labor Day Surge: Is the Deal Market About to Heat Up?

As reported by Bloomberg, “Companies are expected to sell between $55 billion to $65 billion of junk bonds and leveraged loans this month. That is a pickup from August’s low levels, when bankers and buy-siders typically head to the beach, and before the burst of sales that usually follows the Labor Day holiday.” Specifically, leveraged loan finance volumes this September are anticipated to exceed $60.8 billion, the highest post-Labor Day surge since 2016’s highpoint of $57.7 billion. The two primary drivers for the anticipated increased deal flow dynamic are lower interest rates, deal corollary, and M&A demand. The CME’s FedWatch Tool forecasts that the fed funds rate will likely end 2024 at 4.25% – 4.50%, a full percentage point lower than the current rate of 5.25% – 5.50%, which has remained unchanged since the beginning of 2024. As of this writing, SOFR sits close to the middle of that range at ~5.32%, suggesting SOFR rates by the end of the year will be closer to 4.30%. Lower rates translate into greater debt capacity, which in turn translates to higher enterprise values—which all drive increased M&A activity.

Why M&A Demand Is Poised to Rise in Q4

As noted in a recent Bloomberg article, “The pipeline for M&A is robust,” said Cade Thompson, head of U.S. debt capital markets at KKR & Co. “While lately this hasn’t translated into increased transaction volumes, expectations of upcoming rate cuts could catalyze activity.” This year the anticipated uptick in M&A is expected to be exaggerated due to the fact that sellers have been sitting on the sidelines for the last year as a combination of higher interest rates, global geopolitical instability, and recessionary fears contributed to a virtual M&A stagnation. That logjam is expected to break loose in the second half of 2024. The EY-Parthenon Deal Barometer, which incorporates the latest EY macroeconomic outlook, estimates corporate US M&A deal volume will rise 20% in 2024, following a 17% contraction in 2023. This would represent a return to near pre-pandemic levels of activity, with the number of deals in 2024 only about 4% below the average number of deals in 2017–2019. As recently articulated by Scott Nuttall, the co-head of KKR, “The deal market is back. This year, we not only have an open market, we have pent-up supply of deals… coming to markets. So, we are optimistic.” Private equity firms are sitting on more than $2 trillion of dry powder — capital that has been committed but not yet deployed in investments, according to data provider Preqin.

Challenges for Issuers: Navigating Aggressive Market Conditions

While higher reported deal flow is of course good news for buyside players, that does not necessarily mean that liquidity conditions for issuers will necessarily be impaired. To date 2024 has seen market activity characterized as “overly aggressive, driven by a clear supply demand imbalance” (HIG Whitehorse), driving credit spreads and leverage multiples to their most aggressive levels since the fall of 2021. To be a little more granular, SPP has tightened credit spreads five consecutive months in 2024 (100 to 150 basis point reduction) and widened our leverage guidance multiples (0.5x to 1.5x LTM EBITDA). While we are not tightening pricing or expanding our leverage tolerance for the month of September, even with the anticipated “deluge” of post-Labor Day transaction activity, we are not increasing pricing or reducing leverage metrics either.

A Historic Q4 Awaits: M&A Primed for a Big Finish

While it still remains an open question as to whether the post-Labor Day surge will materialize, and if so, the magnitude of the pickup, historically speaking, Q4 is consistently the single most robust quarter of the year. This year will likely be no exception and given the potential for up to three interest rate reductions igniting a rebirth in M&A activity, the one thing we do know is that it’s “About to Get Crazy!”

Tone of the Market

Not surprisingly, market activity is light going into September but expected to pick up precipitously after Labor Day. Investors report that deal flow levels year to date have been consistently below average. Drilling down further, what activity exists is comprised primarily of repricing and refinancing as M&A deal flow continues to lag. Consensus expectation is for a 25-basis point reduction (potentially 50 bp) at the September Fed Open Market Committee (“FOMC”), which will trigger an equivalent reduction in SOFR rates (currently hovering at ~5.33%). With rates coming down and a corresponding enhanced capacity for higher leverage, there is staunch support for a sharp uptick on the M&A front. Nevertheless, currently the supply-demand curve weighs heavily for the benefit of issuers, especially with non-bank direct lenders. In the private non-bank lending sector, credit spreads have stratified in a barbell-like fashion, with higher-quality issuers garnering credit spreads in the SOFR + 5.25% – 5.75% range, while lower middle market and “story” credits routinely price in the SOFR + 7.50% – 8.00% range.

Minimum Equity Contribution

Notwithstanding otherwise aggressive metrics across the market, the level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders are focused on a minimum 50% LTV (i.e., equity capitalization of 50%). More importantly, actual new cash in a deal should also constitute at least 75% of the aggregate equity account. Most lenders remain reticent to provide aggregate leverage in excess of 4.0x LTM EBITDA with only 20% to 25% new cash equity. While lenders will certainly give credit to seller notes and rollover equity, the new cash equity quantum continues to be an essential and primary underwriting consideration.

Equity Investment and Co-Investment

Liquidity for both direct equity investments and co-investments continues to be robust in the new year, and in many cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real skin in the game (i.e., a significant investment of their own above and beyond a roll-over of deal fees). Family offices remain the best source of straight common equity, and, continuing the trend established in 2020, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing both debt and equity tranches.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

Stability in Market Metrics

For the second consecutive month, we are not making any modifications to its Market-At-A-Glance pricing and leverage metrics; this comes after five consecutive months of tightening credit spreads (by a dramatic 100 to 150 basis points) and increasing leverage multiples (by a lesser but still notable 0.5x to 1.5x LTM EBITDA). Is this evidence of a “cooling off” in private market liquidity conditions? The answer is decidedly, unequivocally, no. Driven by the unprecedented growth of non-bank direct lenders (an ~$1.5 trillion lending constituency), issuance conditions in July are as aggressive and competitive as we have seen them in the last five years, and arguably, when it comes to optimal issuance conditions, some of the most astute private equity asset managers have concluded, “This is It.”

The Barbell Effect: Diverging Market Dynamics

While aggregate market dynamics are substantially similar today to where they were in May, there are more subtle influences taking place behind the headline pricing and leverage multiple metrics. More specifically, the market is undergoing something of a “barbell effect,” a transition where the market is dividing between a significant grouping of institutional lenders on the aggressive side of the market where pricing is substantially more competitive (ranging from SOFR+5.25% to SOFR+6.25%) for higher quality assets (i.e., LTM EBITDA >$20 million, a history of consistent growth and performance, etc.) and a significant cluster of investors seeking a higher yield (SOFR+7.5% to SOFR+8.5%) for lower middle market issuers or more “storied” paper (sub $15 million LTM EBITDA issuers, greater cyclicality, and EBITDA volatility). The good news for issuers, however, is that there is more than abundant liquidity on each side of the barbell.

Seize the Summer: Optimal Issuance Conditions

A very strong case can be made that the July to September summer months may present the best opportunity for issuers to take advantage of an exceedingly competitive market. As noted above, issuance conditions in the non-bank direct lending and private credit markets are among their most issuer-friendly in recent history; that translates to more aggressive credit spreads, higher leverage multiples, heightened covenant flexibility, more forgiving “adjustments” to EBITDA, and more expansive acceptance of non-accretive uses of capital (refinancing, leveraged dividends, and share purchase recapitalizations). The only thing not necessarily in the issuer’s favor are base rates; SOFR sits at ~5.32%. After the release of the June non-farm payroll data, the Fed finally seems poised to lower rates (consensus of 2-3 rate reductions by year end). Since the clear majority of non-bank debt financing is at a floating rate, it makes eminent sense to lock in the most aggressive non-rate terms possible today and float down with the market as the Fed loosens credit and cuts the Fed funds rate.

Hedge Your Bets: Defensive Financing Strategies

There is one overriding and even more compelling argument for issuers, heretofore sitting on the sidelines, to enter this private market and lock into aggressive floating rate financing today, and that is for defensive hedging purposes; more specifically, a hedge against (i) adverse macroeconomic conditions and global instability, (ii) operating performance unique to each issuer, and (iii) against a change in market liquidity conditions (lenders incapacity or unwillingness to provide capital as aggressively as they do today).

The June unemployment numbers, while not particularly noteworthy in themselves (June nonfarm payrolls rose by 206,000, beating expectations for 189,500, while the unemployment rate inched up to 4.1% from May’s 4.0%), did contain one component that carries particular significance; specifically, the unemployment rate increased from 4% to 4.1% marking its highest level since November 2021. This rise triggered the Sahm Rule. The Sahm Rule is an indicator that looks at signals related to the onset of a recession. According to the rule, the initial stages of recession are signaled when the three-month average unemployment rate moves above the lowest three-month moving average unemployment rate over the last 12 months by half a percentage point or more. Developed by former Fed economist Claudia Sahm, the rule is based on the idea that, when people start losing jobs, they cut back on spending, and this causes more job losses. A small rise in unemployment can seem trivial in a labor force of 168 million people, but layoffs can escalate quickly, which is why this indicator has been so accurate over time. After Friday’s jobs report, the Sahm Rule rose to 0.43, uncomfortably close to the recession trigger of 0.50.

From a potential issuer’s perspective, the same data set that has economists predicting a reduction in the Fed Funds rate can also spur particularly adverse issuance conditions in the private market in Q4 of 2024. A general slowdown in macroeconomic activity can also signal weaker trading conditions, slower growth, and reductions in EBITDA, which would impair an issuer’s capacity to attract competitive capital. From a lender’s perspective, once a possible credit “down-cycle” is forming, investors tend to stand down, or at the very least, slow down their underwriting efforts to better gauge a possible recession. We know from very recent history that even the perception of a recession has a chilling effect on issuance conditions—lower middle market and cyclical issuers can be locked out of the market, and even higher quality credits can find tough sledding when it comes to attracting recap dollars or tapping higher leverage multiples.

This is not lost on some of the most astute professional equity asset managers. As reported by LSEG, a leading global financial infrastructure and data provider, private equity sponsors tapped the loan market for a record U.S. $227 billion in 2Q24, pushing sponsored issuance for the first six months of the year to over US$400 billion. The half-year total not only represented a record high as well but also exceeded the full-year total in 2023. These sponsors recognize that they can reap the benefits and optimize their borrowing capacity by tapping into today’s exceedingly competitive market and still ride the benefit of a lower cost of capital when the Fed ultimately loosens credit policy and brings rates down. In other words, when it comes to tapping the private credit markets at the best possible time, “This is It.”

Conclusion

In conclusion, the private market is currently offering some of the most favorable conditions for issuers we’ve seen in recent years. The stability in pricing and leverage metrics, combined with the competitive issuance environment, presents a unique opportunity for issuers to secure advantageous terms. By understanding the “barbell effect” and leveraging current market dynamics, issuers can navigate these conditions to their benefit. Now is the time to act and capitalize on the favorable financing terms available in this robust market.

Tone of the Market

Market conditions heading into the dog days of summer are about as robust as they have been since 2021. The sheer magnitude of private capital available for deployment is unprecedented; the size of the private credit market at the start of 2024 was approximately $1.5 trillion, compared to approximately $1 trillion in 2020, and is estimated to grow to $2.8 trillion by 2028. This “excess liquidity” has spurred a wave of competition that has driven non-bank credit spreads to their tightest levels in the last five years. As described in greater detail herein (see “State of the Private Market” below), though base rates remain at comparatively elevated levels (SOFR at 5.32%), at least two and potentially three Fed rate reductions this year are anticipated (i.e., rates will float down later in the year). The same macroeconomic forces, however, that are pushing rates lower may also suggest a less hospitable lending market in the latter part of the year. If economic activity does decelerate, EBITDA generation for many issuers could also slide, and lenders may be increasingly reluctant to extend credit so aggressively. This devolution in trading conditions, or credit “down-cycle,” is a phenomenon witnessed many times in the private market; i.e., a market characterized by higher spreads, tighter leverage multiples, greater credit discrimination, and increased apprehension to fund non-accretive uses of leverage such as recapitalizations. In short, if the only thing keeping an issuer currently out of the market is high base rates, the best strategy may be to issue now when liquidity conditions are robust, lock in aggressive terms, and ride rates down into 2025.

Minimum Equity Contribution

Notwithstanding otherwise aggressive metrics across the market, the level of new cash equity in a deal remains a primary focus point for all leveraged buyouts. Regardless of enterprise multiples, lenders are focused on a minimum 50% LTV (i.e., equity capitalization of 50%). More importantly, actual new cash in a deal should also constitute at least 75% of the aggregate equity account. Most lenders remain reticent to provide aggregate leverage in excess of 4.0x LTM EBITDA with only 20% to 25% new cash equity. While lenders will certainly give credit to seller notes and rollover equity, the new cash equity quantum continues to be an essential and primary underwriting consideration.

Recapitalization Liquidity

The market remains exceedingly recap-friendly, especially where the recap is combined with a more accretive use of capital, such as an acquisition or specified growth capital initiative. Commercial banks remain highly reticent to fund recapitalization financings, absent exceedingly low leverage (<2.0x LTM EBITDA) and LTV metrics (<30% TD/Enterprise Value) combined with a historical credit relationship. Non-bank lenders, however, have little or no reluctance to fund leveraged recaps, with leverage tolerances exceeding 4.5x LTM EBITDA for larger middle market issuers (>$20 million of LTM EBITDA). Leveraged recap activity reached its highest level in the first quarter of 2024 since Q1 of 2021.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502

Commercial Banks Marginalized in Cash Flow Lending

As we enter May, the private market landscape is transforming dramatically. Traditional commercial banks, once the bedrock of middle-market lending, are now sidelined in the cash flow lending arena. In stark contrast, private credit providers are seizing the reins, redefining liquidity conditions with their $1.7 trillion capital base, projected to surge beyond $3.1 trillion by 2027. This influx of non-bank lenders, coupled with their vast financial resources, is driving leverage and pricing metrics to unprecedented levels. For the fifth consecutive month, SPP has reported increased leverage multiples and reduced credit spreads, signaling a significant shift in market dynamics. For middle-market issuers, liquidity conditions are paradoxically both “Better and Worse”—offering new opportunities amid the evolving landscape.

SLOOS Report: Confirming the Trend

Earlier this month, the April 2024 Senior Loan Officer Opinion Survey on Bank Lending Practices (the “SLOOS” report) was released. For those of us in the market every day, the SLOOS report merely confirmed a trend omnipresent since March 2023, to wit, a prolonged withdrawal by commercial banks from middle market lending (especially cash flow loans) and a pronounced unwillingness to “stretch” on pricing and leverage to attract assets. In Fed parlance, that translates to:

“Over the first quarter, moderate net shares of banks reported having tightened standards on C&I loans to firms of all sizes4 Banks also reported having tightened all queried terms on C&I loans to firms of all sizes over the first quarter. Tightening was most widely reported for the maximum size of credit lines, the costs of credit lines, the spreads of loan rates over the cost of funds, and the premiums charged on riskier loans, for which moderate net shares of respondents reported having tightened these terms for loans to firms of all sizes. On balance, large banks reported leaving C&I lending standards and most terms basically unchanged, while most other banks reported having tightened C&I lending standards and terms for loans to firms of all sizes.”

It should be noted that there are some bright spots in the latest SLOOS report, specifically that while a majority of respondents report tightening of credit standards, the pace of bank tightening has eased in the most recent quarter, i.e., fewer banks are tightening in Q1 of 2024 than in Q4 of 2023. Still, as a general proposition, for most middle-market cash flow issuers, commercials remain squarely in “risk-off” mode, with higher pricing (SOFR + 3.50% – 4.00%), lower leverage multiples (~1.75x – 2.50x Sr. Debt/LTM EBITDA), higher fixed amortization (~7.5% – 12.0% in year one and growing annually), and tighter covenant structures (Limitation of Maximum Senior Indebtedness/LTM EBITDA 3.0 – 3.5:1), and maintenance of EBITDA less capex to Fixed Charges (~1.25+:1).

The Rise of Non-Bank Direct Lenders

A recent headline in the Wall Street Journal highlighted the divergent paths of commercial banks and non-bank direct lenders: “Move Aside, Big Banks: Giant Funds Now Rule Wall Street – Giant Investment Companies are Taking Over the Financial System.” Hyperbole aside, the article details the growth of non-bank asset managers and their continuing growth and dominance of a variety of asset classes. As noted in the article,

“Top firms now control sums rivaling the economies of many large countries. They are pushing into new business areas, blurring the lines that define who does what on Wall Street and nudging once-dominant banks toward the sidelines. The growth spurt came out of the 2008 financial crisis, when new regulation curtailed investing and lending by banks, making room for fund managers to expand. Central banks kept interest rates low for most of the following decade, driving investors out of savings accounts and Treasury bonds and into managed funds. In 2008, U.S. banks and fund managers were roughly neck and neck at about $12 trillion of assets. Today, traditional asset managers, private-fund managers and hedge funds control about $43.5 trillion, nearly twice the banks’ $23 trillion, according to a Wall Street Journal analysis of data from the Federal Reserve, HFR, ICI, and Preqin.”

Good News for Issuers: Lower Pricing and Higher Leverage

The private debt segment of these portfolios is merely a fraction of the aggregate assets of these private asset managers, but it still constitutes ~$1.7 trillion of liquidity, and that liquidity translates into fierce demand for assets. Given the current high-rate environment and the improving but still lackluster M&A market, deal volumes remain on the light side in the private market, and that has created something of a mismatch between supply and demand, which in recent months has morphed into one of the most competitive markets in recent years. In the same way nature abhors a vacuum, and a market with excessive liquidity abhors a light deal calendar—and that means good news for issuers—lower pricing, higher leverage, increased DDTL commitments, and looser covenants. To put this in real deal terms, a hypothetical issuer with ~$15 million in LTM EBITDA with total leverage of 4.5x in a non-cyclical sector would likely have gleaned a senior term debt spread of SOFR + 6.50% in March of this year. That spread would be closer to SOFR + 6.00% in April, and if that same issuer came to the market in May, the spread would be closer to SOFR + 5.50%.

Taking Advantage of the Non-Bank Market

It should be noted that whether it be investment-grade bonds or high-yield 144A Notes, rates across the capital markets are more aggressive today than they were in the first quarter of the year, but the magnitude and velocity of the spread compression in the private market is seemingly unprecedented; issuers contemplating an offering in Q2 would be well advised to take advantage of the non-bank market. Of course, as a general proposition, SOFR + 3.50% bank financing may present a more compelling commercial alternative, but with that lower cost of capital comes a multitude of equally less compelling non-price limitations. In short, the private debt market is both “Better and Worse.”

Tone of the Market

The Private Market is beginning to take on a sort of “Tale of Two Cities” vibe this May. For issuers seeking non-bank direct loans, it is quickly becoming “the best of times” (or at least the best of times since 2021). While it is not necessarily “the worst of times” for issuers seeking lower-cost commercial bank financing, lending conditions have really not improved noticeably at all in 2024. In other words, while private credit lenders are solidly “risk-on,” commercial banks remain equally “risk-off.” If anything, as recently reported in the Fed’s Senior Loan Officer Opinion Survey on Bank Lending, commercial banks have tightened lending standards through Q1 of ’24. Notwithstanding the continued retreat from the banks, for the fifth consecutive month, SPP is expanding its leverage multiples and tightening credit spread guidance, driven almost exclusively by non-bank direct lenders. Notably, current “chatter” in the market suggests that non-bank direct lenders are prepared to get even more aggressive levels to attract deal flow in an increasingly competitive market. While pricing and leverage multiples are the most obvious examples of the divergent liquidity conditions between the bank and non-bank lending constituencies, non-bank lenders also offer the capacity to offer de minimus fixed amortization (1.00% – 2.50% per annum), increased committed delay draw facilities, and heightened covenant flexibility.

Minimum Equity Contribution

Cash equity contributions have become the primary focus point for all leveraged buyouts in the private market. Regardless of the enterprise multiple, lenders are focused on a minimum 50% LTV (i.e., equity capitalization of 50%). More importantly, actual new cash in a deal should also constitute at least 75% of the aggregate equity account. For the foreseeable future, the days of 20% – 25% equity contributions are over. While lenders will certainly give credit to seller notes and rollover equity, the new cash equity quantum is the primary metric.

Equity Investment and Co-Investment

Liquidity for both direct equity investments and co-investments continues to be robust in the new year, and in many cases, more competitive debt terms can be achieved where there is an opportunity for equity co-investment. Interest in independently sponsored deals continues to be strong as well, but investors will require that the independent sponsor has real skin in the game (i.e., a significant investment of their own above and beyond a roll-over of deal fees). Family offices remain the best source of straight common equity, and, continuing the trend established in 2020, credit opportunity funds, insurance companies, BDCs, and SBICs will actively pursue providing both debt and equity tranches.

*Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

Stefan Shaffer
Managing Partner and Principal

Stefan has over 30 years of experience in the private market includes hundreds of transactions in North America, Asia and Europe. Prior to becoming a principal at SPP Capital, Stefan was a Vice President in the Private Placement Group at Bankers Trust Company where he was responsible for origination, structuring and pricing of private placements for the Capital Markets Group, both nationally and internationally.

sshaffer@sppcapital.com
Ph: +1 212 455 4502