In the wake of the covid-19 crisis, it may be hard to take a positive view but you should always try. For direct lenders and others in the private debt market, the light at the end of the tunnel was supposed to be better terms and documentation as the borrower-friendly market that had seen a profusion of covenant-lite loans and aggressive terms was brought to an end.
Has that shift actually happened, however? Anecdotally, it does appear that some much more constructive conversations are taking place. Sponsors, we hear, are more willing to drop EBITDA addbacks – or at least certain types of EBITDA addback – in such a volatile economic climate where it is recognised that certain assumptions about company performance cannot be made. In addition, sponsors do not appear to be pushing the envelope on cash leakage and dividends, recognising that cash should stay within businesses for the next year or two of uncertainty. As one market source put it to us: “Some of the signs of a very frothy market have disappeared.”
It’s also worth bearing in mind that, when it came to degrees of borrower-friendliness, the ‘mainstream’ private debt market was always less willing to sell off the family jewels than the broadly syndicated market. The point has justifiably been made by direct lenders in recent years that they are often still able to incorporate at least one meaningful covenant in deals, while rejecting the most egregious suggestions put forward by lawyers on the other side of the table.
However, it’s most certainly not the case that we have now entered some sort of golden era for private debt lenders when it comes to documentation. While there may be improvement overall, it’s clear that deals in certain sectors – consider software, for example, and its strong recurring cashflows – are witnessing competition at least as hot as before the covid-19 outbreak. Indeed, it may even be hotter, as a larger number of lenders gravitate towards a relatively small universe of covid-resilient companies. For these businesses, that competition may very well extend beyond pricing to the devil in the fine print.
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