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Speakers at the Debtwire and Creditflux Mid-Market Forum in New York last week highlighted how competitive the market has become - even more so than Europe - when it comes to securing funds from LPs. With the market becoming more mature, LPs have become more sophisticated and are starting to put pressure on managers to stay away from aggressive lending practices when it comes to leverage or covenants, with a view of assessing how they will fare in a downturn.
LPs are not only looking at where they could lose money, but also who could actually be in a position to benefit from a dislocation.
“What we see more commonly is that they expect there will be a period of downturn and they are assessing who they want to partner with. That’s the most frequent question, how are you structuring your deal, are your covenants lite? And if there is a dislocation in the market how are you prepared to capture it as an opportunity,” said a US direct lending fund.
US direct lenders are experiencing very similar challenges to their European counterparts, with increased competition driving aggressive documentation changes.
Despite the pressure from LPs, speakers said EBITDA addback flexibility, cov-lite or ‘cov-wide’ – covenants set at 35%-40% without a step down - and other cash leakage loopholes, such as shifting assets outside the lending pool from the collateral package, are all working their way into the middle market. The USD 20m to USD 30m EBITDA segment is the most competitive and where sponsors have an opportunity to play one fund off against another to extract more flexibility on docs and reductions in price, the speakers noted.
“Trying to balance doing the best deal for the LP but deploying and continuing to do deals in a competitive market at the same time is the biggest challenge,” said another US direct lender. “We keep hearing from LPs that it’s too competitive but then hey here’s a 100m bucks!”
But despite competition being the most talked-about topic for the day, speakers said the rate of deployment has been satisfactory, at 18-24 months, driven by a healthy deal flow and the fact that US banks have retreated much more from the mid-market than in Europe.
“Europeans are not deploying as fast as expected. The market is not that big and banks are still operating so there it is much more limited one way, so the US the rates of deployment are faster,” said a third US direct lender.
Another trend highlighted on the day was larger players squeezing out smaller ones, given their ability to deliver scale, speed and reliability, according to a fourth US direct lender.
“You need scale. You need to be able to underwrite at least USD 100m. You need a USD 5bn platform – it doesn’t have to be one fund, it can be across funds,” he said.
The mid-market CLO industry was also highlighted on the day. Speakers said the industry is on the up, with increased interest from Japanese banks and a wider range of investors.
“Three or four years ago you’d have three or four investors in a mid market CLO and now it’s not uncommon to have 20 or so,” said a CLO expert.
Debtwire will be hosting its European Mid-Market Forum in London on 20 June. See the agenda and sign up by clicking here.
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