In the race to finance a boom in private equity-driven buyouts, more business is heading to direct lenders, who are tapping dry powder at an ever-faster clip and sweetening deal terms to attract borrowers.
One notable example is Thoma Bravo‘s roughly $10.7 billion take-private deal for San Francisco-based software company Anaplan in March. The tech-focused PE giant secured $2.6 billion in debt financing from a group of direct lenders—including Owl Rock Capital, Apollo Global Management, Golub Capital, and Blackstone Credit—within several days. Thoma Bravo bypassed leveraged loan financing and other debt markets that have traditionally handled large debt transactions for leveraged buyouts.
Direct lenders are expected to continue to grab more market share in funding large PE deals, while growing into a more viable alternative to high-yield bonds and traditional banks’ syndicated loans.
Private equity activity remains robust so far this year, with sponsors taking advantage of low valuations in the public market for acquisitions.
Lenders in the syndicated loan market are taking a more cautious approach as they weigh credit risks alongside headwinds like rising interest rates, inflation and geopolitical tensions, requesting higher pricing and flexible deal provisions. That often adds uncertainties to the syndication process.
Issuance in the junk-rated debt market has slowed down this year following Russia’s invasion of Ukraine. Leveraged loan volume in February stood at $28.7 billion, compared to $71.6 billion a year earlier, according to data from LCD, a unit of S&P Global.
This allows private debt investors to jump on opportunities, filling a void as others pull back from a relatively risky segment of the lending market.
Deals with direct lenders have been appealing to sponsors and borrowers because of their ability to close rapidly and provide greater confidentiality and certainty in execution. They also offer lower costs in underwriting, making them more attractive than syndicated loans.
“In the last few weeks, when financial sponsors were preparing to raise debt financing for deals, they began to run a dual-track process even if they were initially considering a broadly syndicated loan,” said Jake Mincemoyer, head of the US leveraged finance practice at Allen & Overy. “Sponsors and companies were trying to compare potential deal terms offered in the [syndicated loan] market with what could be achieved through a privately placed unitranche loan.”
Moreover, some debt products are difficult to obtain from the syndicated loan market, creating an opening for private debt lenders.
One such example is the delayed draw term loan, which allows a borrower to draw down money as needed over time. It’s an important debt tool for buy-and-build strategies, which need a lot of dry powder to be able to act quickly and efficiently for add-on acquisitions.
However, getting such deals done in the syndicated loan market is considered costlier and more difficult under current market conditions.
“All these advantages really outweigh a small amount of incremental cost [charged by private debt],” said Gregory Cashman, head of direct lending at Golub Capital, a direct lender with over $45 billion in capital under management.
And thanks to the ample dry powder raised in the last couple years, direct lenders now have greater firepower to compete with banks—and in some instances supplant them—in providing debt financing for large buyout deals.
There is no shortage of mega-size unitranche loans that are over $1 billion, which was rarely seen several years ago. Those deals are typically offered by one or several deep-pocketed private credit funds and business development companies.
Last year, Thoma Bravo turned to the private credit market to fund its roughly $6.6 billion buyout of Stamps.com.
But in order to access some large deals, direct lenders have had to relax covenants to be considered competitive.
One significant change in the market is that more direct lending deals are structured as covenant-lite for competitive reasons, while historically direct lenders would require their credit facilities to include a financial covenant that was tested at the end of each fiscal quarter, according to Eric Klar, co-head of the US private credit and direct lending group at White & Case.
Klar pointed to the usage of springing financial covenants as one example. Under such provisions, covenants would only spring to life when a borrower draws down its revolving facility to a certain threshold amount. In other words, these covenants only protect creditors who provided revolver and, sometimes, term loan A lenders.
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