Private Capital Call

Before Covid the persistent view of private credit was too much capital chasing too few deals. Transaction inflation was resulting in tight spreads, high leverage and weak terms. 

When Covid hit this balance shifted dramatically in favor of the investor. Deal supply dried up, lenders retreated, and terms strengthed. But within weeks central bank liquidity ended that run. 

Today the private credit pipeline is at record levels, fueled by a combination of near-zero risk free rates, low relative value for riskier assets, and volatility from more correlated strategies such as public equities...

One of the more fascinating aspects of the past 18 months has been watching the divergent economic narratives between headlines and data.  

The Bureau of Labor Statistics reported a record high 10.9 million job openings in July. The three largest sectors comprising this increase were healthcare, finance, and food services.  

Yet there also less than 9 million people unemployed. How can there be such a shortage of experienced workers when there are more jobs than jobless?

Last spring we were shopping for garage doors. Lumber prices had skyrocketed – almost to the price of gold. So we chose steel. As did everyone else. Wood is now cheaper. And we’re still waiting for our doors.  

The industry publication Supply Chain Management Review reported that 2021 is on a record pace for factory fires – up 150% this year caused by “gaps in regulatory and process execution as well as a shortage of skilled labor in warehouses.”  

They also analyzed data showing supply-specific shortages were up over seven-fold from 2020. These are due to merger-related activities, as new owners drive for operating efficiencies, leaner inventories, and lower costs. All while still attempting to meet evolving customer demand...

“The #unitranche was invented in response to broken capital markets, when banks were backing away. Today it’s thriving when markets are booming.”  

The size of these financings has also grown dramatically. How large could they get? We remember the same questions being asked about broadly syndicated loans in 2007.   

If the largest direct lenders collaborate, a $5 billion unitranche could come by year-end. Particularly with a large software company...

According to Refinitiv LPC, US #unitranche volume came to almost $22 billion last quarter – the highest level they’ve tracked historically.

At the same time, one-stop risk/return dynamics have moved in favor of issuers. The average debt/ebitda is now at a record high 5.9x, with all-in Libor spreads hovering around 600 bps.

As we told M&A magazine, recently, “The disintermediation away from the loan syndication market to private credit has accelerated in this hyper competitive M&A climate. That’s included their credit providers...

In October 2015 we published a white paper: “The Unitranche – What it is, and Why it Matters.” In it we called the unitranche “one of the most innovative, and increasingly popular, financing tools in the middle market.”

The following year Ares reached a milestone by leading, for Thoma Bravo’s Qlik Technologies, the first $1 billion unitranche. Other mega-tranches soon followed as larger issuers recognized the value of one-stop financing.

The broadly syndicated market, after all, involves more time to distribute and more lenders to negotiate with...

As we conclude our European private credit series, let’s review what we’ve learned:  

1. Europe suffered a similar Covid slump (and enjoyed a similar rebound) as the US. Deal volumes are at record highs. Europe retained the country-by-country distinctions they had pre-Covid.   

2. Pricing in the US and across the pond is close. Though European upfront fees are higher, certain terms are decidedly more issuer-friendly. Banks have been more aggressive than direct lenders in some locales...

This week’s Chart of the Week highlights how US and European private debt fundraising came into Covid with a head of steam, slowed, and has now picked up.  

Our content partner,   , recently published excellent commentary related to investors’ views of the “European opportunity.” One CIO said it started looking more attractive when US yields dropped precipitously last year. Since then, the difference in yields as shrunk.   

According to PDI, there’s $116 billion of funds in the North American market, $85 billion in Europe and $12 billion in the Asia-Pacific region.

We continue our conversation with Lincoln International’s European office.  

“US and Europe are competing markets,” Xenia Sarri told us. “The US was increasingly aggressive six years ago, but now terms are more favorable in Europe. There are no baskets around restricted payments. No excess cash flow sweeps, no amortization and tighter flex language.  

Are there pricing differences? “Arrangement fees are twice as high in Europe as in the US,” Dominik Spanier said. “We think this is because the US is a more mature market. But margins (as our Chart of the Week shows) are very similar. Also, the European secondary market is less well-established.”...

Calculating European direct lending volume is a bit dodgy. But we can triangulate from other metrics.  

The par amount of all leveraged loans was €15 billion in 1998, per S&P/LCD. It grew to 140 billion before the GFC, and is now a record €240 billion. Conservatively assuming one-third is held by non-banks, that puts it at just under €100 billion.  

That’s consistent with Preqin data. As our Chart of the Week highlights, assets under management for European direct lending is almost $160 billion, including about $50 billion of dry powder...