In recent years the growth of the private debt space in Europe has enabled direct lenders to truly shed their “alternative” status, with many market observers now instead discussing a golden age for these players. That said, challenging global macro-economic and geopolitical issues loom over all parts of the market, and private debt is no exception.
From 2020 through 2022, more LBO financings were supported by direct lending deals than by the broadly syndicated loan (BSL) market in every quarter except 4Q21. Back in 1Q20 — when the pandemic was just emerging — the direct lending to BSL ratio for such deals was 2:1, with banks already pulling back from the lending market. By 4Q20 that ratio had spiked to 4.3:1 (with 30 direct-lending and seven BSL deals), while in 4Q21, when the market had mostly recovered from the pandemic impact, it was down at 0.6:1 (with 13 direct-lending and 20 BSL deals). However, by 4Q22 the ratio of direct lending to BSL deals was back up at 4:1.
Despite the recovery for broadly syndicated loan deals in 4Q21, in general terms the banks have retrenched substantially in the past two years, giving market share back to direct lending funds. What's more, banks are subject to more regulation than private credit providers, including BASEL II, III and IV, as well as certain capital adequacy rules and enforced limitations on credit risk. “Direct lenders are not regulated as much as banks are, and if that changes it would be a very different landscape,” one banker said.
Route change
Illustrating this trend, some recent transactions that typically might have been broadly syndicated went down the direct lending route instead. French insurance company April, for example, was first acquired by KKR on an all-equity basis, and the sponsor eventually chose a large club of direct lenders — led by CVC Credit, along with Apollo, Blackstone, Credit Suisse Asset Management, Park Square, SMBC, and Crescent Capital, among others — to provide a unitranche of roughly €800 million to finance the acquisition.
Lenders here also provided an acquisition line of roughly €100 million. The loan is covenanted, and leverage is roughly 5x times EBITDA, with pricing in an E+500 bps context. This deal is unusual in that it is a unitranche — thereby providing swift financing and a simplified structure — but is also documented like a term loan with relatively low leverage, alongside pricing and covenants that are similar in nature to a broadly syndicated loan.
Threading the needle
Despite such successes over the last year, the difficult market backdrop is pushing private lenders to be more disciplined and chase the best quality credits.
“The most important thing for us is good credit and governance — you don’t want a company led by one person only, rather you want a team,” one direct lender said. “In that sense we are all going to chase the same good credits.”