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One direction: despite primary market malaise direct lending is powering ahead

While debt primary markets are all but silent, large direct-lending facilities are still making their way over the line. In Europe, The Access Group recently secured the Continent’s largest direct-lending facility to date, comprising a GBP 2.2bn covenant-lite unitranche alongside a GBP 1bn acquisition line from a club of lenders to refinance existing debt. Only a month ago in the US, Blackstone led the financing on a USD 4.5bn unitranche to support Hellman & Friedman’s acquisition of IRI.

There are many features of direct lending that have been aiding its continued activity despite the current macroeconomic headwinds. For example, having limited lenders – commonly only a single lender on all but the largest deals – on a transaction allows a flexibility to the offering that would usually hamper wider syndication. Specific risk tolerances of both the borrower and lender are more easily catered for, which is now a significant benefit, while inflation, monetary tightening and supply-chain difficulties are meaningfully eroding earnings.

This also makes conversations over expected covenant breaches or potential missed payments far easier, as relatively few lenders must be contacted and appeased, meaning resolution is more likely to favour both parties, and solutions can be reached sooner.

Another positive feature in this landscape is that private lenders are able to provide funds at higher leverage levels than regulations placed on banks would allow. This enables certain borrowers to access capital that otherwise would be impossible to receive by conventional financing. While this encourages borrowers to raise debt in the private market, it is also a positive for lenders because of the higher-yielding debt. The interest from both sides of the equation has contributed significantly to direct lending’s rise.

Rising star has limits

Despite the impressive figures boasted by direct lending in times when the traditional markets are experiencing significant challenges, private credit has still only accounted for 5% of the total European leveraged finance market in recent years.

There are certainly negatives to the direct-lending market to be wary of, and that go some way to explaining why it has not risen above its steady percentage of total issuance in recent few years.

Restrictions on banks’ lending following the global financial crisis have been both a blessing and a curse for the sector. As we go headfirst into what appears to be the formation of a recession, and this time without the huge amount of monetary stimulus that abounded during the pandemic, the higher risk exposure taken on by the private market has the potential to prove its undoing.

As private credit continues to spread into the large-cap space, traditional financing routes are providing strong competition. Cheaper financing is available to those companies that are able to raise debt in the syndicated market. This is due in part to an active secondary market afforded by the size and relative transparency of the market in the large-cap space. In addition, the greater number of lenders and smaller allocation size provides more diversification in a portfolio. There is also a quicker due diligence process for syndicated loans, of approximately two weeks, while in direct lending this process often takes months.

Ultimately, direct lending and syndicated debt are complementary instruments catering for different risk/reward profiles. The equilibrium formed between them only serves to increase the efficiency of the capital markets.