A quarterly survey from Refinitiv shows that both banks and non-bank financial companies alike are increasingly willing to push the envelope on leverage, both on a first-lien basis and in the aggregate.
In the financial data provider’s Fourth Quarter Middle Market Lender Outlook Survey, the proportion of banks willing to lend at 6.5x-7.0x increased by more than 13 percentage points, a jump from 7.7 percent to 21.4 percent at the start of the fourth quarter of last year.
Among alternative lenders, the number of firms willing to lend at 6.5x or higher increased from 26.3 percent to 36 percent over the period. Notably though, the number of firms willing to lend at greater than 7.0x dropped from 15.8 percent to 4 percent.
“It’s amazing to me in a year how much folks are willing to push leverage given where we are in the cycle,” Refinitiv mid-market loan analyst Fran Beyers said. “Banks pulled back a few years ago because of leveraged lending guidance, but that’s in the rearview mirror. Now they are trying to compete with direct lenders.”
Almost one in four credit managers, 24 percent, are willing to accept more than 5.5x for first-lien leverage. At the start of the fourth quarter of 2018, that figure was only 5 percent. A plurality, 42.1 percent, a year earlier said that 4.0x-4.5x was the maximum amount of first-lien leverage they’d accept. In the most recent survey, a plurality, 36 percent, responded that that figure was 4.5x-5.0x.
“We really need to go through a cycle to see which direct lenders have staying power,” one private equity sponsor said in the survey. “It’s a new ecosystem that hasn’t been fully tested yet.”
Even so, investors have piled into private debt, giving credit managers, particularly those doing private equity-backed deals, a stockpile of deployable dollars.
“The direct lending market still has an abundance of capital,” Beyers said. “Direct lenders are going to stretch for key sponsors because that market is more relationship-driven. While I do think that direct lenders are being aggressive on really good credits, overall they are being more selective this year.”
This comes as the syndicated debt markets have become much pickier, she added.
“In the broadly-syndicated and upper middle markets, a lot of the CLOs and bigger investors are giving extra scrutiny to the B2 and B3 rated credits,” Beyers explained. “In the past few weeks, many deals have flexed up.”
Portfolio performance has remained relatively solid – 72 percent said performance is “stable” – though the share of lenders seeing “softness” in their portfolio has tripled over the past year, from 7 percent to 26 percent.
Notably, the default rate in the coming cycle will not be a good indicator of borrowers’ financial statements due to the cov-lite or cov-loose structures that have become a mainstay of capital markets today.
“This cycle, I don’t think we can look at defaults as a good gauge [of corporate financial health],” Beyers said. “It’s going to be very backward-looking in this cycle because everything is cov-lite or has wide covenants.”