On the cusp of bigger challenges

Many lenders are still in the comfort zone, as performance holds up and sponsors make concessions on deal terms, but few expect that to continue through the tests ahead.

“Private equity firms are actually being friendly to us,” one professional at a mid-market direct lender told us recently. It’s the benefit you reap when you suddenly become the only source of finance in town.

As another source said: “If you want to get a deal done today, that deal will be a private credit deal.”

Much private debt capital has gravitated to the upper end of the market this year given the difficulty – or even impossibility – of obtaining financing in the broadly syndicated loan market. Consequently, one participant at our recent Europe Summit claimed that most people’s definition of a mid-market deal has increased from an upper-end-of-the-range size of $50 million not that long ago to around $300 million today. Indeed, some of the larger lenders are now holding deal positions of $1 billion or more.

It’s also noted that, when the broadly syndicated loan market was open, it was only possible for private debt firms to compete by offering covenant-lite loans. This is no longer the case now that the competition has dried up – few borrowers are now feeling sufficiently emboldened to dig their heels in over such relative trivialities as a covenant or two. Moreover, sponsors are realising they never really needed all that flexibility in the documentation that they negotiated so hard for – much of it turned out to be an unnecessary luxury.

Another reason for lenders to feel optimistic resides in equity cushions, which are much bigger these days. In the wake of the global financial crisis many deals burned through value and got to the debt much quicker as deals that completed around the 2005/06 period were typically very skinny on the equity layer and very heavy on the leverage.

But being the favoured source of finance and finding yourself in a strong position when it comes to the documents does not in itself make for promising market conditions. Observers say deal processes have slowed down and differences are emerging over both valuations and the amount of leverage companies can support. However, volume is for the moment holding up reasonably well as sponsors pivot away from selling mode to making add-on acquisitions.

While there is currently some optimism around portfolio performance and valuations, few expect this to last through the forthcoming tests of the winter months and a marked slowdown is expected next year. As one source told us: “We expected to be put to the test with covid and we weren’t. We’re all going to be tested now.”

Write to the author at andy.t@peimedia.com