Never have the choices for issuers been more varied, nor the market dynamics more complex

Randy Schwimmer

Head of capital markets and origination Churchill Asset Management

Direct lending deal terms are becoming more attractive in Europe

In 2016 we reported in a Lead Left white paper that the US, challenged by energy concerns, was seeing significant loan fund outflows. Meanwhile, Europe was still in its early QE days — good for issuers, not so much for investors. Then, as often happens, capital flowed to fill the vacuum, changing investing dynamics — the US became cheaper, Europe more expensive.

The onset of covid caused spreads to widen in Europe and contract in the US, but this year that differential has shrunk. Overall, this dynamic underscores our view that opportunistic value plays are no substitute for a long-term investing strategy. But from a cross-border borrower’s perspective, capital efficiency means having more options in structuring your financings.

No surprise then that being a private credit provider in an emerging post-covid European private credit world carries special opportunities and challenges. Never have the choices for issuers been more varied, yet never have global and national market dynamics been more complex.

The US and Europe are competing markets, a friend at a leading European debt advisor tells us. “The US was increasingly aggressive when I came here,” she says, “but today terms are more favourable in Europe. For instance, there are no baskets around restricted payments. Other examples we’ve seen include covenant holidays lasting nine months or longer. Add to that no excess cash flow sweeps, no amortisation and tighter flex language. Covenant head room is now 35%.”

Cov-lite lending is costly for borrowers

What about cov-lite direct lending? “It’s less about size than having a reason to do so, such as volatile ebitda,” the debt advisor answers. “You can certainly find someone to do it for small borrowers, but it’s expensive. For $30 million ebitda and below, you usually need at least one covenant. These are things where the US has largely held the line because the European market is more fragmented with different jurisdictions.

“We’re working on a deal where a US lender is financing a target in the UK for a US sponsor. With UK docs and denominated in pounds sterling, it’s a good example of geographic arbitrage.”

Are there pricing differences? “Arrangement fees are twice as high in Europe as in the US,” she says. “We think this is because the US is a more mature market. But margins are very similar. Also, the European secondary market is less well established. So when covid happened, German loans didn’t trade.”

Structures and timelines are tight

The biggest issue right now seems to be getting deals appropriately staffed. “The activity level overall is very high right now,” the advisor reports. “The first half of 2021 was so busy it created bandwidth issues. It’s tough to get people to work on deals. Structures are very tight. In acquisition financing the timelines are so short that sometimes the buyer will close with all the equity, then refinance later with lenders.”

Here private capital has distinguished itself from regulated entities. “Direct lenders can be nimbler. You can commit and close deals with them by the time you’ve negotiated the NDA with the bank. And some of the larger funds are starting to compete with the syndicated loan market. We saw several European examples in 2020, especially when borrowers turned to direct lenders to avoid taking market risk, given the volatility. As M&A processes are getting more competitive and timelines more compressed, private capital solutions tend to be more valuable.”

And what about consolidation among direct lenders? It’s not happening so far, says the advisor. “They are raising fund sizes, but first-time funds are tougher. There are about 100 UK direct lenders today. That includes funds targeting issuers with less than $20 million ebitda. Some are even doing non-sponsored and minority-owned transactions — a change from five or six years ago.”

The direct lender’s holy grail is finding a good-performing company, our friend concludes. “But,” she says, “those have an easier time finding cheap bank debt, putting direct lenders at a disadvantage. The direct lenders risk ending up with borrowers the banks won’t finance.”

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Global credit funds & CLO's

October 2021 | Issue 239

Published in London & New York.