2018 was dominated by direct lenders
2018 will likely be seen as the year of ‘private credit’, a trend that has been clear for some time, with the direct lenders dominating the mid-market leverage finance arena at the expense of banks. Whilst private credit fund raising was lower in 2018 compared to the previous year (€22bn in 2018 versus €32bn in 2017), direct lenders have significant dry powder. But, with lower M&A volumes, one of their key challenges remains deployment.
The extent of capital available and competition amongst funds has seen documentation become increasingly borrower friendly, with tighter pricing and syndicated market terms taking hold in the mid-market arena. This includes: covenant-lite; covenant loose; greater EBITDA flexibility; portability clauses; freebie baskets; ability to re-leverage; holdco PIKs; etc.
However, terms alone are not enough and direct lenders have sought to distinguish themselves in other ways, such as size. With the larger funds flexing their muscles to compete head on with the syndicated loan or HY bond markets, they are demonstrating they can write large tickets, move quickly and remove syndication and flex risk. Or indeed, moving down the scale, backing smaller but fast growing businesses that will need follow-on funding.
Whilst banks would like to see more senior club deals, super-senior has been the theme this year for them. Less so the traditional super-senior revolving credit facility (RCF) only, increasingly we see banks providing super-senior term debt as a means of deploying more capital, maintaining relationships with borrowers, a chance to pitch for ancillary services, and lower cost of capital for borrowers.
LBO transactions per region
So what does 2019 have in store?
Despite the disappointing end to 2018 both in terms of returns for liquid credit and issuance, Q1 2019 appears to be off to a good start with issuance pipelines remaining strong. However, the combination of rising interest rates – notwithstanding the Fed having lowered guidance on hikes and the ECB only tapering towards the second half – and increased political uncertainty across major European economies, means some market volatility is to be expected.
In the mid-market, we expect to see a continued trend amongst banks to favour super senior positions and private credit portfolio managers to take advantage of any liquid market disruption, further disintermediation of the underwritten loan market or indeed the public markets.
Defaults are broadly expected to remain low, partly due to their backward rather than forward looking nature, partly due to the ongoing benign, albeit volatile, credit environment in the first half, and partly due to the flexibility in credit documentation. This last point could present real opportunities for borrowers.
At DC Advisory, we continue to be very busy on the refinancing front, helping borrowers take advantage of opportunistic market windows and situations. However, we are seeing from borrower and shareholders a focus on maximising flexibility in loan documentation and ‘future proofing’ their capital structure.
Interest rates (three month Libor) vs. volatility (VIX)
- There was a slowdown in leveraged loan volume in Q4 2018, which is expected to continue into Q1 2019 as the deal pipeline is impacted by Brexit uncertainty
- For strong, contract underpinned / recurring revenue credit stories, borrower-friendly market-leading terms are still achievable
Type of refinancing by structure (UK)
Strong UK deal issuance continued into the end of 2018, with fund led deals comprising around half of transactions.
- Leveraged financing activity slowed in Q4 2018, and reflecting reduced M&A activity
- Demand is strong for good credit stories, however, lenders remain disciplined for weaker credit stories or highly-leveraged structures, which has led to a number of flexed transactions
Number of deals per quarter (France)
Strong leveraged financing activity has continued in France, with issuance broadly flat at 26 deals in Q4 2018 (vs.27 in Q3 2018) with LBOs accounting for over two-thirds of deal flow.
- Leveraged lending activity recovered somewhat in Q4 2018, following an inactive third quarter
- Mid-market pricing has remained steady and has not been impacted by pricing corrections in the large cap space in light of ‘bumpy’ syndications through the summer
Issue volume per deal type (DACH region)
In Q4 2018 the DACH leveraged loan market saw a rebound in activity, with a majority of deals funded by senior bank clubs.
- The leveraged loan market slowed in Q4 2018
- Of note, direct lenders financed all LBOs in Q4 2018, thus solidifying their position as an attractive financing option in the mid-market
- International banks continue to compete for large transactions backed by international sponsors
Number of deals per quarter (Spain)
Following a peak in activity in 3Q18 with 17 deals tracked in the quarter, Spain has seen a slowdown in leveraged loan activity in 4Q18, with just 5 deals.
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