The coronavirus pandemic halted issuance of syndicated middle market loans in the second quarter, mirroring a plunge in activity for large-cap counterparts. Uncertainty and extreme volatility froze activity, closing the curtain on buoyant conditions in the syndicated market at the start of 2020. LCD data of new syndicated loan volume from borrowers with $350 million or less of debt reflected the stoppage. The upheaval left some transactions in limbo, but a raft of government stimulus restored confidence. Among other things, the federal programs fueled a jump in secondary loan prices, key to restarting primary credit markets. A turnaround in new credit issuance occurred around the start of May, sources say. New deals gradually emerged, including transactions negotiated before and after the COVID-19 sell-off.
Private credit providers returned to the market before the syndicated market started to thaw. Once considered the antidote for bear market conditions in the syndicated market, private credit has evolved into common practice over the past decade. These lenders, who directly originate loans and retain all or part of them, have played a growing role since the credit crisis a decade ago. In one measure of how the market has changed, the share of directly originated loans held in business development company (BDC) portfolios, as of March 31, reached a high since LCD began tracking BDC data.
Behind the trend toward private credit are borrowers and their private equity sponsors, which have opted to forgo the syndication process, choosing instead for single-lender or small-club solutions, with a handful of lenders. Dealing with a smaller lender group, of two to five, as opposed to dozens when a loan is syndicated, can be simpler when negotiating credit agreement amendments and workouts.
In the second quarter of 2020, lenders who waded into the market found that conditions had turned in their favor following years of razor-thin spreads and loosening loan documentation terms. For deals that crossed the finish line once investor confidence returned, yields had increased, covenants had tightened and leverage levels had declined, sources say.
But not everyone could play in the COVID-vintage of deals. And those lenders who had cash to put to work offered up smaller sums, requiring sponsors to make more phone calls and engage more participants than when the large buy-and-hold was du jour.
The crisis is shedding light on the strength of capital structures and lending standards that governed the pre-coronavirus era. In addition to underwriting, choice of sectors is playing a huge role in today’s success stories – as well as a degree of luck. Some wins have come from unlikely places: businesses such as gourmet cheese distribution. Another bright spot has been tech, particularly software providers that benefit from pricing models that result in steady revenue.
Access LCD’s complete Q2 Middle Market Review below for notable Q2 transactions, the latest liquidity drawdowns by U.S. BDCs and a full list of U.S. private credit deals for the information technology sector.
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