What’s Leverage Got To Do With It?

A persistent misunderstanding in leveraged lending is using leverage as the sole metric for market frothiness. Drawing such conclusions is like judging an episode of Keeping Up with the Kardashians by the first two minutes. That takes at least three minutes.

It’s tempting, of course, to be carried away by the headlines. Both Thomson Reuters and S&P LCD have highlighted in recent months how this year’s loan market has featured more loans with leverage approaching that of 2007 transactions.

To illustrate the point, see our Chart of the Week. Almost 55% of LBOs this year have sported leverage, defined as total debt-to-ebitda, over six times. Compare that to 56.7% for the pre-crisis, market topping level in 2007.

Similarly, S&P is reporting recent large cap LBO leverage of 6.6x. Yikes!

Missing in this analysis, though, is equity contributed as a percent of overall capital to these buyouts. The latest data (per S&P) show sponsors contributing on average almost 35% of the target’s balance sheet in the form of equity. That’s up from 2007’s 30%.