Banks are set to score a victory against direct lenders by poaching a private debt loan and announcing its refinancing in the broadly syndicated loan market as soon as next week, with more trades set to follow the migration into the cheaper public markets.
The deals would mark the first time in Europe that debt provided by direct lenders to sub-investment-grade corporates owned by private equity firms is refinanced in the bank or bond markets, said debt specialists. With call protections on certain direct loans now close to expiring and technical conditions strong, it's an opportune moment for banks to pounce.
“Once we have had a successful first quarter of loan repricings, private equity sponsors and issuers will focus attention on their current unitranche structures that have ended or are nearing the end of their call period," said Andrew Lawson, head of capital markets at Permira Credit.
"It’s clear there will be a number of unitranches that refinance into the broadly syndicated market. What were once 600bp–650bp private credit financings could end up in the broadly syndicated loans market at 425bp–450bp, underpinned by strong demand from CLO managers requiring issuance on the asset side."
Bankers are confident of securing a number of deals, with sources saying a pipeline of potential trades is set for the first half of the year.
“We have a couple of mandates to refinance unitranches," said one leveraged finance banker. "They are not ... imminent; the timing of those is more like March, [although] maybe there's one that might be earlier.”
A second leveraged finance banker, who also expects some first-quarter activity, said: "It's certainly a theme."
The first of the refinancings is expected to hit the market before the end of next week, said to be an issuer from a difficult sector but backing from a highly regarded sponsor should trigger strong demand.
Sources said potential refinancings sounded out for the first quarter range from €300m to €800m.
Attracting interest
Swedish construction engineering company Eleda, owned by Altor Equity Partners, was tipped as a possible deal. Although the size and timing of that refinancing are unclear, there should be a Swedish krona element to the trade. Altor didn't respond to a request for comment.
Having been previously financed privately, some potential issuers have expanded their businesses to an extent that they may now go to the public market for the first time and attract interest from investors.
"There is a friction point for issuers who have reached a certain point through growing and had been financing using the private markets," said Mathias Neidert, head of public market research at investment consultant bfinance. "They could now consider syndicating a loan and you have a number of companies experiencing that friction."
But he cautioned that there are constraints hindering the takeout of unitranches in the distributed market.
"It will never explode as there are limitations to these shifts," he said. "It depends on flows and interest in the asset class and whether it is attractive to recycle privately negotiated debt into broadly syndicated loans. If the flows are not there and there is not the money to absorb these deals then the opportunities will dry up. It is a tactical opportunity for banks at the moment."
Pricing edge
Bankers are confident they have a definitive edge over direct lenders as the pricing on some vintage unitranches was at a margin of around 600bp or more and the euro loan market is substantially cheaper.
"If you put in place a Euribor plus 625bp direct lending loan in 2022, and your non-call period has run out, you can probably refinance that, cheapening your cost of debt by 150bp–200bp," said the second banker. "That can be quite material. It's not appropriate in all circumstances but we certainly have a number of sponsors looking at this sort of thing."
A third leveraged finance banker said the pricing available in the loan market provides a powerful argument. “That's something that banks have been pitching, particularly for deals done in the last two years – sponsors don't want to pay the 600bp over coupon that they have to for direct lending."
Even with potentially cheaper pricing on offer elsewhere, some sponsors could see the benefits of remaining in the private debt sphere – especially if they are worried that pricing on syndicated deals may be increased relative to the promised level via a "flex" during syndication.
"Private credit has won market share in the last 12–18 months partially because of the risk in the syndicated loan market that you would maybe be flexed and end up with the same pricing as a private deal but without the bells and whistles," said James Staunton, head of structured finance Frankfurt at Berenberg.
"You would think once the sponsor is out of the non-call period and if the broadly syndicated loan market has improved then the borrower would consider moving markets with the refinancing. But for others, where there is potentially future M&A or a buy-and-build strategy, the sponsor would recognise the benefits of the private credit world are so overwhelming that they would accept higher pricing to have that strategic flexibility."
While bankers expect many private debt refinancings to end up in the leveraged loan market because of sponsors’ preference for shorter call protections and fewer covenants, they are also keeping an eye on the high-yield market, which also offers very attractive pricing.
“[The drop] in underlying rates as well as the tightening of credit spreads firmly brings high-yield back as an option for many kinds of deals,” said a fourth banker.
Given how supply across leveraged loans and high-yield bonds has plunged in recent years, many on the buyside would welcome new investment opportunities.
“The high-yield market has shrunk," said Brent Finck, global co-head of high-yield at Aviva Investors. "We've had several years now of continued rising star activity outweighing fallen angels. So I do think that there is appetite and interest from the high-yield investment community to have some new names [in the market]."