PE sponsors request "portability" amid M&A slump, and private credit delivers

Private credit providers have looked at private equity’s long wish list and found “portability,” a feature that allows a loan to move with a business when it’s sold.

Aiming to please, some private credit lenders have been willing to provide this to private equity firms and their borrower companies.

Recently, a handful of loans have emerged with a portability feature. The feature appears to be more readily available in the private credit market than the syndicated loan market. Market sources say talk about portability has increasingly become part of negotiations for private credit loans.

“This is something a private credit firm can bring to the table to distinguish themselves from the broadly syndicated loan market,” said Jeff Katz, a partner at Dechert, who has represented both lenders and private equity firms.

“Being able to port a senior secured loan can potentially be of real value to a sponsor. While there’s no guarantee that the vision of a prospective buyer is going to be the same as that of the seller who approved the covenant package and other terms of the facility to be ported, it’s a luxury to have this option in place,” said Katz.

It’s no surprise that when M&A is challenging, and financing is harder to come by, requests for portability increase from private equity sponsors.

The feature has emerged from time-to-time in credit markets. Syndicated loans and high yield bonds have commonly featured a change-of-control put, requiring an issuer to repay the debt at the moment the asset changes hands.

Not just anyone
The current version of a portability feature is governed by rules, of course.

Typically, a portability feature in a loan would be good for 18-36 months after close. It is usually limited to one-time use in the lifetime of a facility. There are leverage tests to determine that a company has not deteriorated too much before a loan is "ported," sometimes requiring leverage to be at the same level as at the time of origination.

Some rules govern a potential buyer, that this is the type of acquisition they would do in the “ordinary course” of business, i.e., buy similar types of businesses. Terms involve fees for the lender at the moment the loan is ported.

“The average buyer out there is going to prefer a portable deal,” said Bill Eckmann, who oversees private debt investing for Macquarie Capital in the Americas.

“There are examples of syndicated deals with it, but they are much more difficult to obtain. It would be very hard to do that today.”

One reason a private credit provider would agree to the feature in the current environment is confidence in the business, i.e., a belief that the asset is so solid that there will be future demand, by lenders, to provide financing for it.

With origination activity more subdued in private credit than in 2021-22 peak levels of the post-Covid frenzy, competition has increased for attractive deals. A portability feature makes most sense when an asset nears the likely moment of changing ownership, market participants say.

Spurring market on
Market participants say spreads on private credit loans narrowed in the third quarter of 2023. There is growing evidence that terms and covenants have eroded, particularly on larger private credit loans. A portability feature likely represents a concession by a lender, too.

But it’s possible that the benefit to a lender could outweigh the risks.

David Hayes, who typically represents private equity sponsors as part of Reed Smith’s global corporate group, based in Chicago, said more credit facilities with portability features have emerged this year. Those deals likely closed in 2022.

He said this increased frequency of portability is not a reflection of transactions placed when spreads were the lowest. Rather, it is a consequence of M&A generally.

“It creates a new ability to market and acquire a company,” said Hayes. “The whole idea of portable debt is to facilitate M&A.”

“This trend has less to do with the credit facility or the criteria, but more to do with the environment for doing deals,” Hayes said.

One such example in the syndicated market was CoAdvantage, the human resources services provider backed by Aquiline Capital Partners. In July, the company completed its $575 million six-year covenant-lite term loan B at the tight end of talk at pricing of Sofr+CSA+550, with a 1% floor and an OID of 98 through a Deutsche Bank-led arranger group.

The facility is portable subject to corporate ratings of B-/B3 with stable outlooks; maximum 50% LTV; gross debt-to-EBITDA of no worse than 5.25x; a sponsor with $1 billion in AUM; and a two-year expiry.

Documentation revisions were made ahead of pricing relating to the EBITDA definition and incremental and portability ratios, as well as the addition of quarterly lender calls. Proceeds from the deal, which was upsized by $25 million, refinanced first- and second-lien loans and funded a dividend.

This article originally appeared on PitchBook News