The first half of the year has passed with little friction in the European direct lending space, and while the COVID-19 crisis has by no means been resolved, the market is eagerly awaiting the final quarter. of 2021 with a well-filled agreement. pipeline. “We are totally overworked and we are already preparing agreements in September,” said a market player.
The transactions that should populate the market after the end of summer break will be mainly LBOs, financed by direct lender loans Even at the height of the pandemic, LBOs made up the bulk of market activity. In the first quarter of 2020, for example, some 73% of European mid-market transactions supported acquisitions, depending on the number of transactions, while 15% were refinancings (note that these figures are anecdotal, as reported by LCD News. ).
The story was more or less the same in the following periods, until the second quarter of 2021, where the distribution was around 81% for acquisition financings versus 11% for refinancing, and 5% for recapitalization (versus 1% on average for the latter category over the previous five quarters), according to LCD News. In the first quarter of 2020, some 55% of transactions supported buybacks, rising to 70% in the fourth quarter of the same year, before falling back to 62% in the second quarter of 2021.
In 2020 and so far in 2021, all classes of lenders have been battling for the best deals in the European mid-market space, seemingly undeterred by the pandemic, and with an incredible amount of cash to play with. . Direct lenders have squeezed themselves into all kinds of financing arrangements, taking advantage of the banks’ busyness with government lending and their different tolerance for risk.
Since the start of 2020, the direct lending market has overtaken banks when it comes to middle market lending, sources say.
However, banks have certainly not gotten out of the business and might even end up working with direct lenders to some extent.
“It will be necessary for banks and direct lenders to work together, with instruments such as first-out / last-out facilities,” said one market player. Indeed, managers are finding more and more ways to work with bank lenders as the market matures. Pulsant’s recent deal provides an example, which saw banks and direct lenders working together to offer an extended senior facility (Antin Infrastructure Partners acquired Pulsant, a UK data center and cloud infrastructure provider , Oak Hill Capital and Scottish Equity Partners).
Direct lenders have also challenged the largely syndicated loan market on larger deals, and it looks like this wrestling match has no upper limit. “Historically… private debt was not able to issue a check of the size that the largely syndicated loan market could do, so borrowers didn’t have many options,” said Aymen Mahmoud, partner. at McDermott Will & Emery. “Pricing of largely syndicated loans. Was much lower than that of private debt [historically]. Today, private debt funds can issue large checks (some $ 2 billion), so borrowers have had significant option value.
“Private debt funds can also scale a bit faster than heavily syndicated markets with fewer touchpoints, no syndication material required, very little rating involvement, and so on. In addition, pricing in private debt markets has reduced significantly from price levels seen in 2012, for example, due to a low interest rate environment and significant dry powder availability. Combining the above with the fact that the regulatory overlay associated with more traditional BSL banks, to more hasty action during difficult times, the patient (less regulated) private debt capital was able to further strengthen its position within the community Finally, many traditional largely syndicated loan-type clearing banks are believed to have been overburdened with demands for liquidity during the pandemic, giving the large amount of private debt credit somewhat more marketing opportunities. in the last 18 months nths. “
Transactions involving a private equity sponsor represent the overwhelming majority of transactions in the European direct lending space, and on average since the first quarter of 2020, 88.5% of transactions recorded in the mid-market per quarter have been sponsored, according to LCD.
Many direct lenders specializing in the lower middle market are attracted to entering into sponsorless deals in order to penetrate uncharted and lucrative territories, but this is not an easy approach, and few alternative middle market lenders have the ability to do so. necessary documentation allowing them to offer offers without a sponsor. These assets have not been “educated” in terms of private lending by a sponsor, and therefore the origination of such transactions represents a very different perspective from the ordinary lender / sponsor relationship. In addition, the initiators of transactions without a sponsor must branch out to deal with advisers – sometimes up to the accountant of a small town – while the private lender then becomes a “sponsor” in its relationship with the management of the company. – “almost as if the lender himself took the keys to the business”, as one direct lender explained.
Leverage and size
Regarding the profile of the transactions themselves, the average EBITDA of mid-market transactions is around 24.5 million euros, while the average quarterly transaction size is 124 million euros in Q1. ’20 to T2’21. Most often, transactions of this size have already been entered by private equity funds.
Over the past 18 months, the European middle market has shifted towards the more resilient sectors that naturally have higher levels of debt. But although the average leverage has increased, market participants claim that the dam has not broken and that leverage multiples easily stay within the level agreed in their documentation.
The highest quality assets that have attracted both sponsors and lenders have also seen their valuations rise sharply, along with leverage multiples. While private equity funds have been praised for sharply increasing their holdings in order to cope with these valuations, some operations have seen an increase in debt leverage as well as installments of in-kind payment. One of the most discussed transactions of 2021 to date is the acquisition by Blackstone of the Belgian industrial asset Desotec, for example, which, after a very competitive process, was financed by a unitranche cov-lite facility of 8. , 5x from Macquarie and Blackstone Credit.
Despite this example, the average multiple of the European mid-market since the second quarter of 2020 is around 5.08x. Although it is relatively high, it is very much in line with the leverage offered by alternative lenders. “I don’t think Desotec is setting a trend,” said a debt advisor. “While it’s obvious this is a competitive market, you need a business that is strong enough to be able to handle that much leverage.”
While some industries attract funds like bees for honey, interest from lenders is mostly focused on computers and electronics, healthcare and business services.
However, as market participants report that competition in certain industries is getting ‘too much’, lenders and private equity funds are starting to turn away from the frenzy and turn to other assets. “We’re at a point where private equity and direct lenders don’t want to spend an enormous amount of time working on a deal that they would likely lose to competition, or even take too much risk to get the deal. “said a source of debt counselor.
The educational services segment is a good example of an area where lenders are diversifying into new sectors, particularly in France. Over the past year, for example, deals such as those for ACE, Skill & You, Talis, the College of Paris, L’Ecole Française, Medisup, AD Education, ISPS and Amphi have all filled the pipeline.
Indeed, France is one of the most active regions in direct credit, with the United Kingdom in pole position and Germany in third position. In 2020, France accounted for 22.7% of total LCD measurement transactions, the UK 27.3% and Germany 18.9%. So far in 2021, this split has increased to 28.6% for France and 32.5% for the UK, while Germany’s share has fallen to 14.3% of transactions.
ESG on the radar
A notable change in the European direct lending market since the start of the pandemic has been the introduction of environmental, social and governance pricing criteria for transactions. Interest in ESG was boosted by the health crisis, and now a number of mid-market agreements include pricing mechanisms linked to ESG-related key performance indicators, or KPIs.
“In five years, ESG investing will represent a third of all global assets,” said one ESG lender. “The only problem is that we don’t have enough perspective yet. Yet this is an area of increasing scrutiny, and KPIs are gradually normalizing.”
Indeed, while the structure is still relatively new, the terms are now increasingly standardized. For example, the Loan Market Association and the European Leveraged Finance Association recently published a “Best Practice Guide for Sustainability Leverage Lending” to provide practical advice to market participants and improve market transparency.