Direct lenders/CLOs dynamic

There has been a clear convergence between the syndicated markets and the direct lending markets over the years, with direct lenders serving as the last resort for ‘hung’ deals in the syndicated markets while direct lenders have also been taking cornerstone anchor positions in larger syndicates.

And with the Debtwire’s European Direct Lending Forum in London next Thursday, we speak to market participants about this dynamic.

Direct lenders take lion’s share of deals

Several companies have gone down the private route, taking out the risk associated with pricing flex and deliverability. Sources point to several deals in the market, snatched by direct lenders, who could have easily gone to the syndicated markets.

Parkdean Resorts (April 2023), previously a syndicated deal, turned to direct lender Ares Management to refinance. “Royal DSM is the perfect example, jumbo Advent deal where the vast majority went to direct lenders, and a small portion of the deal was CLO liquidity,” says one source. "April Group, a €1.2 billion deal, with 9-12 direct lenders and KKR supporting, that’s an obvious deal that should have been done with the syndicated markets.” 

Luis Mayans, head of private debt at CPDQ, says the firm has 16% of its assets under management in Europe but has big growth plans for the continent – and, in particular, direct lending. 

The firm launched its direct lending strategy in 2017 and has deployed around €5 billion of capital directly over the past three years.

“We’re seeing more deals from large cap sponsors – it used to be once a year discussion but now we’re talking to them regularly for almost all their transactions,” he says. “The market share of direct lenders at this moment in time is probably around 80/90%.”

The battle between direct lenders and CLO managers however is not necessarily a bad thing, says Deborah Cohen Malka, partner and CLO portfolio manager at AlbaCore Capital. 

“Last year, when the CLO issuance market was on pause, the bid from private debt enabled some banks to de-risk their balance sheets and provided refinancing solutions which in turn helped the performance of the CLO market”.  

“Sponsors want the optionality and, at the moment, it’s a good equilibrium. For a good quality credit, deals in the syndicated market are being done around 475-500bp at 97-98 and private debt market spreads around 625-650bp but with more leverage,” she says.

And while the private debt market is strong, it’s not for every sector - some deals are better suited to the syndicated loan market.

Floris Hovingh, managing director in Perella Weinberg Partners' debt advisory business, adds: “There are certainly benefits of targeting a liquid high yield follower base as you can tap them for future deals and its ultimately going to be cheaper capital.”

“But if there’s a company executing a transformational business plan like buy and build strategy, and therefore material pro-forma’ing of ebitda, it’s harder to track what the underlying profitability of the business is. That becomes more difficult for CLO investors, who prefer relatively straightforward stories fitting in with their risk parameters.”

Direct lending: club deals, add-ons and returns increase, but fundraising slows

With large deal sizes, club deals have increased in popularity. 

“Last year, deployment activity was very intense, but the fundraising was less so. A lot of these large direct lenders that used to write cheques for €1 billion are now writing cheques for €150-250 million,” London-based Mayans says.

Amid the volatile backdrop, credit firms have acknowledged a slowdown in fundraising. In Blackstone's Q1 earnings call, for example, Steve Schwarzman, chairman and chief executive officer pointed to a more "challenging" fundraising environment but added the firm was "seeing the greatest day for private credit solutions, given higher interest rates and wider spreads." 

This echoes results from a BlackRock survey stating over 50% institutional investors globally plan to add to their private credit allocations.

The slowdown in fundraising however has meant sponsors are now seeking external lenders for add-ons, leading to a diversified pool of lenders.  

"Sponsors don’t want to be too dependent on one lender, who could eventually be maxed out and not be able to support the business with add-ons every couple of months if they run out of or are struggling to raise capital," adds Mayans. 

But direct lenders are being better compensated.

“Over the last 24 months, for high quality deals, we could see a return of zero Euribor plus 550/575bp and 2.5% fees,” he explains. “Now returns are 3.5% interest rates, spreads that were 550-575bp are now 625-675bp, and fees are 3%.”

Two key drivers of this are interest rates, but also less competition – both in terms of the lack of capital markets, but also less competition among direct lenders because of fewer inflows, sources say.

In addition, lenders are regaining bargaining power at the table for terms, for example better ebitda adjustments or having covenants in a deal that would have historically been cov-lite.

Pick up in M&A activity

European CLO issuance year-to-date stands at around €8.7 billion (including delayed issuance tranches), down marginally from €11.4 billion at the same point last year, with the slowdown attributed to lack of triple A CLO buyers and new issue leveraged loan paper.

Amend and extends and add-ons have dominated loan issuance figures this year, with new money scarce. But market participants appear to be positive. For the right credit, the loan market is more open - first with more CLOs being priced and second because investors are getting a little bit of cash repayments on the few assets that are being sold, which they can reuse into primary transactions.

Appetite and demand for paper is clearly there –what's missing is the gap between underwriting and syndication that needs to be bridged by banks, CVC’s head of European performing credit Guillaume Tarneaud told us last month. 

Cohen Malka says she is seeing a bit more activity than others originally expected on the M&A side.  

“We are starting to see M&A activity pick-up both on the corporate and sponsor sides,” she says. “When we talk to sponsors, we get a sense that they are more actively looking at deals, but transactions are taking more time. I expect that if we see a reopening of the M&A market, we should have more primary loan and bond activity towards Q4.”

But while the high yield debt market has shown improvement and some green shoots, Hovingh says the market remains sensitive to central bank narrative and inflation.

There is also a preference towards non-cyclical double B-rated credits of seasoned issuers.

According to Debtwire, high yield bonds in the market include: Adler Pelzer-/B3/B- rated, €350 million senior secured 2027 note, IPTs at 9.5%, 92-93 OID; Cedacri, B/B3/B- rated, €250 million senior secured 2028 FRN, IPTs at E+ 550bp, 92-93 OID; Odfjell Drilling, B2/B2/- rated, $390 million senior secured 2028 note, IPTs at 9.25%-9.5%;  O-I Glass, BB-/Ba3/- rated, €500 million senior unsecured 2028 green bond, IPTs at mid-to-high 6% areas; and Ziton, €275 million senior secured 2028 FRN, investor call 8 May.

“We’ve seen more confidence on the macro front with positive movement in equities, receding volatility, inflation coming down (except for UK) and GDP growth remaining broadly positive (albeit with a risk of a shallow recession in H2 in some countries),” according to Hovingh.

“But for there to be a material change in the market, and more opportunistic credits tap financing, we need to see a pivot in terms of the interest rates and a clear signal that we’ve passed the worst and we’re on a downward trajectory for interest rates, likely resulting in a swell of new liquidity entering the high yield market.”

Panellists at Creditflux’s CLO Symposium said private equity managers are sitting on a significant amount of dry powder and are keen to deploy at the right valuations.