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 Channel Futures


‘Top Grading’

‘Top Grading’

  • Written by Claudia Adrien
  • July 8, 2022

“You may have some companies struggle a little bit more and face potentially lower demand and higher borrowing costs,” Fear said. As a result, some investors may choose to “top grade,” that is, doing only A and B deals, meaning those involving the Best and the Better companies, those with the strongest fundamentals.

“Nobody admits that they rank order A, B and C deals—meaning good, better and best—but almost everyone we talk to on the equity and credit side say they are not doing the C, or good, deals right now, they’re focusing on the better and the best,” Fear said. “Those deals might not miss any beats, because there are strong fundamentals, healthy growth rates, and a lot of capital out there. For the better and the best companies there is plenty of debt and equity capital at not too different a spread than before.”

Both Fear and Van Gorden noted that interest rates on PE-backed MSP deals have risen since the beginning of the year, but still remain extremely low, especially compared to rates in the wider corporate lending market.

Rates on PE-backed MSP deals are typically floating-rate loans with reference rates tied to LIBOR (London Interbank Offered Rate) with a 1% “floor.” Now that the 1% floor has been exceeded, increases in LIBOR have a one-to-one effect on borrowing costs.

“If people compare this to the more liquid, broadly syndicated loan markets, where loan spreads are wider, we may need to make some pricing adjustments to narrow that gap,” Fear said. “Are the risks to growth and the risk to execution a little higher than they were? The answer is probably yes, but it’s not material to the overall equation yet. If it becomes more material, then overall leveragability is going to come down and that will filter through to valuations. But we are not seeing that just yet. What we also haven’t really seen are people saying they have to reduce leverage because debt service is going up.”

 

 

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Claudia Adrien

Claudia Adrien

Claudia Adrien is a reporter for Channel Futures where she covers breaking news. Prior to Informa, she wrote about biosecurity and infectious disease for a national publication. She holds a degree in journalism from the University of Florida and resides in Tampa.

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