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Private credit’s growth has for many institutional investors effectively raised the minimum tranche size in which they will invest, and this may create a unique opportunity for direct lenders hunting for business in the absence of a robust M&A market.

In 2018 and 2019, the syndicated market was far more active in providing smaller facilities to support middle market private equity portfolio companies. Now, those are loans are coming due, and direct lenders may be in a prime spot to step in with new capital.

Five and six years ago, private credit did not command the market share that it does now, while the syndicated market for smaller transactions has evolved to encompass clubbier executions.

“Institutional loan investors are looking for liquidity in a tranche, and for some, if that tranche is less than $400mn it may not be a fit,” Antares Capital Senior Managing Director Graham Manley said.

A look at the year-to-date direct lending takeout data (when private credit refinances or otherwise takes out an institutional loan) bears this out. To date, 14 names exited the syndicated market with private capital, paying down $7.64bn of capital. Of those, seven paid down loans less than $400mn.

Dresser Utility Solutions and CHA Consulting proved to be the smallest at $150mn and $175mn, respectively. Dresser Utility refinanced its debt with a $335mn credit facility, while CHA Consulting received a $305mn term loan to finance its $700mn buyout by HIG Capital.

“Many of our clients are looking at the less competitive sub-$500m deals,” Akin Partner Bill Brady said. “Some of those companies probably don’t have access to some of these banks, and it puts the private debt funds in a more competitive spot. Credit funds are very nimble; they can move up and down market very efficiently.”

The syndicated market has picked off private credit borrowers at a notable clip. To date, nine borrowers issued $6.88bn of new loans, and those nine issuers were mainly concentrated in larger deals. Moreover, tightening spreads put syndicated lenders in a position to fend off private credit.

Among the syndicated market’s wins was Wood Mackenzie’s $1.315bn issuance that cleared at S+350 at 99 to refinance a $1.244bn unitranche loan priced at S+675 and Groundworks’ $965mn syndicated term loan strip that priced at S+375 to refinance a $940mn private financing priced at S+650 with a 25 bps leverage-based step-down. Both institutional loans cleared at 25bps tight to the loan end of talk.

On the small end, Trulite and Crisis Prevention Institute each issued $400mn term loans. (Dye & Durham issued a $350mn term loan, but it also issued $555mn of coordinated secured notes for a total debt issuance of $905mn.)

Both Trulite and Crisis Prevention proved to be particularly attractive credits. The former in its institutional debut garnered B2/B ratings, while the latter received B3/B- but had de-leveraged considerably, as LFI previously reported.

“If you’re going to approach the broadly syndicated market for an issuance of less than $400mn there will be an increased focus on credit quality and metrics such as loan-to-value and leverage, among others,” Antares’ Manley said.

One banker who works on both syndicated and private solutions said that banks are not shying away from smaller deals but that those deals must have the right structures. Institutional investors, the source said, do not want to lose assets to the private market.

The banker though acknowledged that many are going to the private market, noting that the check sizes among direct lenders have gotten larger, allowing for even easier execution on deals for under $400mn or $500mn.

Generally, for a company with a smaller deal to tap the syndicated loan market, it must be a “relatively clean story,” Adams Street Partners Head of Private Credit Bill Sacher said.

That includes businesses with steady profitability, a lack of vulnerability to “potential disruption” and companies that do not have a lot of management turnover, he said. Sacher also noted though that many of the businesses checking those boxes may find the “best execution” in the broadly syndicated market currently.

Note that smaller deals that direct lenders pull away from the syndicated market do not necessarily face a considerable price increase because private capital is more expensive.

Take the recent STV Group refinancing that came from Blackstone, KKR and Oak Hill Advisors; the $350mn funded term loan cleared at S+525. It refinanced an originally $225mn LBO financing and an originally $45mn incremental for M&A. Those financings priced at S+525; it is worth noting that the new private loan came in at the same spread as the old syndicated loan.

In addition, direct lenders have come under pressure to cut interest rates for existing loans. They have begun repricing some of their prized assets, sources said, to ward off both the syndicated market and other direct lenders from poaching some of the best credits.

The competition has created a pricing arbitrage for the borrowers.

“The problem is there’s not as much deal activity,” King & Spalding Partner Todd Holleman said, citing the perpetual buyer-seller valuation gaps as the principal cause. For attractive credits looking to refinance, lenders will “jump all over” those opportunities, he said.

As a result, sponsors and issuers are in a good position to weigh both private and institutional loans.

“If a deal has sufficient scale, most private equity sponsors now run a dual-track process in which they weigh financing proposals in both the direct lending and BSL markets,” Antares’ Manley said. “A sponsor may lean towards either a direct lending or BSL solution depending on the size of the transaction and the bandwidth of their deal team.”

But the waters are getting muddier. The provider of a syndicated option or a private option may be one in the same. Banks are developing private credit platforms via partnerships with asset managers, and some direct lending firms also offer a syndicated loan product.

“Depending on the process a sponsor may lean towards either a BSL or direct lending solution,” Manley said. “Firms that provide structures in both the BSL and direct lending markets are uniquely positioned to support a sponsor should they want to weigh both options but without the complexity of a dual-track process.”

As private credit continues to grow though, the floor for broadly syndicated deals – and what is the purview of mainly direct lenders – may continue to creep up.

“As the [private credit] market continues to grow and evolve, I think the minimum deal sizes [for the syndicated market] are likely to rise,” Adams Street’s Sacher said. “It’s a very similar phenomenon that we saw back in the early 2000s when minimum deal size for effective high-yield execution grew over time.”

Push and pull of syndicated market vs. direct market

Perhaps the biggest storyline of the first three months of the year proved to be the tussle for deals between institutional loan investors and private credit managers and the results of that competition.

Over the course of the Q1 2024, direct lenders paid down more than $6bn of syndicated debt. The borrowers in the broadly syndicated market issued almost $25bn that, among other uses, included the paydown of private credit debt.

Note the “Volume of BSL to Take Out Direct Lending” chart includes institutional issuances paying down private credit loans included both those that were privately placed for existing institutional issuers and those refinancing a capital structure fully provided by direct lenders, i.e., there were not syndicated issuances in place.

Due to the competition, direct lenders began repricing their portfolios, to ward off competition from both the syndicated market and other private credit firms. Companies took advantage of this dynamic; Parts Town refinanced its pricey tranches of debt a S+598 and S+650 to a single S+475 via a $2.1bn refinancing.

In addition, banks began stepping up the leverage they offered, notably a 6.36x for Husky Injection Molding and 5.8x for Cotiviti. Last year’s average leverage for LBO loans, was 4.1x/4.2x, according to LFI sister publication Covenant Review.

The direct market routinely offers leverage north of 5x. In January, the $305mn term loan for CHA Consulting’s LBO by H.I.G. Capital, underwritten off an approximately $55mn EBITDA, was levered at just under 5.5x.

In February, the $480mn refinancing for Thoma Bravo-backed Venafi, underwritten off of an almost $80mn EBITDA, closed with a leverage of more than 6x. In March, the $350mn term loan to STV Group levered the company at about 5x, off of roughly $70mn EBITDA.

PIK’ing keeps surfacing in private, syndicated loan markets

PIK-toggle features and PIK instruments kept showing up in both the private credit and institutional loan markets in Q1 2024. This came off an elevated new-issue PIK-toggle atmosphere last year: 9.4% of such deals contained a non-cash-pay component, according to Lincoln International.

Among the notable loans from the first three months of the year, the financings for PDI Technologies ($1.3bn), the industrial fire business of Carrier Global ($1bn) and iRhythm ($150mn) each allowed for the possibility of PIK’ing term loan interest.

While a comprehensive list of deals with PIK-toggle features may prove a difficult lift – private credit is supposed to be private after all – two large direct lenders said these deals are a “small portion” of the transactions getting done.

The first lender noted that generally these PIK-toggle features are not part of the opening offer, and they are used for companies that are performing but cashflow-constrained. The second lender anticipated more deals would have contained a PIK option.

Interestingly, though, the second lender said, those that have the PIK option aren’t really taking advantage of it because it comes at a premium; the source likened the PIK feature to an “insurance policy” if cashflow gets “tight.”

For instance, the PIK-toggle feature in PDI Technologies, which carried an S+550 cash-pay pricing, increased to S+575 with the option to PIK 1.25% and carried a second option to PIK a higher portion of the interest at an even higher rate.

Although the feature has long existed in the high-yield universe, particularly for Holdco issues that rely on upstreamed payments from opco entities, PIK has been touted as a flexibility that direct lenders are uniquely positioned to offer. Direct lenders generally have more flexibility in the terms they offer than the syndicated loan market, which is constrained somewhat by the requirements of CLO vehicles that comprise much of the BSL investor base. But private credit LPs are not necessarily onboard with the option.

One source that advises LPs said the focus for many pension funds, insurance company and the like that allocate money to private credit is the current income portion, which is facilitated from cash-pay interest. Total return, in which PIK would be factored into, is still important but it is less of a focus for LPs.

In addition to PIK-toggle features, several sponsors in the broadly syndicated market have put up PIK preferred shares, alongside new institutional issuances, to de-lever the company. These include Husky InjectionCrash Champions and MyEyeDr.

Spreads for direct loans tighten rapidly

Private credit spreads came in materially in Q1, and while this is no surprise, the stats are illustrative of how quickly the market dynamic changed. From the Q4 2023 to the Q1 2024, private credit spreads came in by 45 bps and 64.7 bps since the Q3 2023’s high of 650.1bps. Spreads for 2B loans came in additionally, by 32.6bps from Q4 2023 to Q1 2024 and 30.4bps since Q3 2023.

Middle market CLO hits record volume in Q1

Pricing volume for middle market CLOs hit a record high in the first three months of the year at $9.99bn, barely edging out the previous record in Q4 2021 when $9.49bn priced. Golub Capital did two deals in the quarter; the first proved to be the largest at $1.34bn and the second for $399.53mn deal had the tightest AAA spread at 181bps.

Going rates for all have come in substantially since Q4 2023

Lincoln International’s Private Credit Snapshot, which records going-rate market pricing and leverage, showed that spreads for first-lien, unitranche and second-lien across all market sizes has come in since Q4. Perhaps most notably, the unitranche pricing for companies with $40mn to $100mn of EBITDA and those with more than $100mn of EBITDA. For the former, unitranche pricing decreased from S+575-675 in October to S+525-625 in April, while the latter fell from S+550-650 to S+500-600 over the same time period.

Private credit carries higher leverage than syndicated deals

LFI sister publication Covenant Review found in its Private Credit TrendLines that private credit deals carry 5.32x average net first-lien leverage and 5.49x average net total leverage, larger than the syndicated market’s 3.62x and 4.18x, respectively.

Andrew Hedlund
Managing Editor
LevFin Insights



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