Large cap lenders fish in mid-market waters
Sizeable direct lenders in Europe have responded to banks winning deals from large-cap issuers by joining the throngs in the crowded mid-market arena, accelerating spread compression for smaller borrowers.
The level of adjustment means mid-market issuers can price unitranche deals just 25bp wide of their larger cap peers.
“Over the last three or four months, everything just got compressed; there is not a huge amount of spread difference between the small company and the big company,” said an origination head at a sizeable direct lender which has been active in large-cap transactions.
The margins for mid-market transactions, generally translating to borrowers with Ebitda standing at €20m–€100m, have shifted down from over 600bp a year ago to around 500bp–550bp, direct lenders and debt advisers said.
The skinnier margin has narrowed the gap between mid-market and the large-cap direct lending deals, with the latter stuck at around 475bp over the past 12 months.
A prominent recent example of a large-cap direct lending deal was the £1.5bn-equivalent debt package backing Permira’s £2.7bn acquisition of London-listed financial services firm JTC.
The multi-currency debt package – including a £1.1bn-equivalent interim facility B – was set at 475bp over Sonia/Euribor for the sterling and the euro tranches, and 450bp over SOFR for the dollar tranche.
“The larger direct lenders don't want to compete all the way down to the pricing that the broadly syndicated loan markets can offer because some Double B credits are printing with a 250bp margin now and some Single Bs can be in the low to mid 300s,” said Andrew Lynn, managing director and head of debt advisory in Europe at Baird.
“The larger direct lenders are not going to those levels. They are instead coming back into the mid-market, bringing further competition. Mainstream unitranche spreads post-Covid were in the 600bp-plus range, but the only place where those spreads are relevant now is in the lower mid-market or for storied credits.”
Big wins
Several sizeable direct lenders, including Apollo, Blackstone Credit & Insurance, CVC Credit and Goldman Sachs Asset Management, seized the opportunity to snap up a series of trophy credits from banks during 2022 and 2023, when the broadly syndicated markets were shut down due to the war in Ukraine, which triggered greater volatility.
However, banks have been striking back aggressively since last year, thanks to a benign syndicated market where pricing has continued to tighten.
“It’s very hard for sponsors to go the direct lending route for these large deals unless they can get a lot more leverage there – so you are seeing a near 100% hit rate for the syndicated market to win them,” said a leveraged finance banker.
In addition, the lack of large-cap dealmaking this year has further driven those large-cap direct lending players back into the mid-market.
“There's not been as much large-cap activity, and so we had to go down to smaller assets,” the origination head said.
The benefit of lending to smaller firms is to become an incumbent lender, which allows the lender to deploy more capital over time as the firms grow.
Ares and Barings have adopted such a strategy, focusing on the European mid-market across different jurisdictions over the years, leading them to build sizeable credit portfolios that consistently request growth capital.
“There are some great companies that are just small, where we'd like to get early incumbency and then help them grow over time,” said the origination head.
Despite fierce competition, direct lenders are tending to stick with covenants for smaller borrowers.
“The bar for investing in a smaller company is higher because generally they're less diversified,” said the origination head. “They've got fewer levers to pull if something goes wrong or if they get some macro headwinds. The idea is the market is trying to delineate around the €30m–€40m mark and [keep those below] as covenanted – at least whilst the businesses are still that small.”