Comment: The shifting debt landscape

The recent entry of new lenders to the market was encouraged by the requirement for banks to deleverage, low interest rates, surplus investment capital and the development of new products. These new sources of funding have provided private equity with competitive alternatives and the ability to tailor packages.

This year opened against a nervous backdrop, driven by macroeconomic fears in the shape of Europe's failure to address major challenges, Brexit concerns and uncertainty over the direction of the Chinese and emerging markets. While banks have recognised the need to strengthen their products to regain market share, alternative lenders are also improving their offerings.

The syndicated loan market started the year with a bang, with LGC, Webhelp, Eurogarage and Infinitas all launching as soon as the primary window opened. The uncertain backdrop meant the market was in price-discovery mode and initial indications saw pricing expand slightly compared with 2015. Leverage contracted, albeit slightly, for similar reasons.

The high-yield-bond market opened on a subdued note: Leaseplan pulled its issue in January (returning in March), but Solera had some success, although the notes were scaled back and the TLB expended to take up the slack. Issuance remains down on the corresponding period, which is to be expected as bond markets are more skittish than the loan market.

The mid-market opened the year with spreads slightly inside the larger syndicated loans, as banks and direct lenders continue to be active. The former have adopted a more aggressive approach, perhaps, in part, driven by a reallocation of capital from emerging markets. At the same time, the latter continue to expand, as existing funds ramp up firepower and new players seek to gain a foothold. For these reasons, spreads are often inside margins seen in larger deals, as banks and larger mid-market deals continue to see erosion of lender protection.

Mid-market protection erosion
Although covenant-lite and covenant-loose deals have been focused towards the larger deal sizes, could we see this erosion of lender protection filter further into the broader mid-market? This might be a step too far. However, headroom on maintenance financial covenants from both banks and unitranche providers has increased, as they seek to respond to increased competition and it equips equity providers with enough competitive tension to negotiate aggressively.

But how far can these terms be pushed? Despite the move to looser terms in other areas, restricted payment clauses have largely remained resolute with lenders taking a more cautious approach, as they look to ensure any change in the nature and scope of the business does not undermine the basis upon which the original credit decision was made.

We provide further detail on these, as well as other loan documentation changes that are creating value opportunities for mid-market borrowers, in our latest edition of Capital Thinking: From Small Print to Bottom Line.

An interesting time indeed, but, looking at the softening of the US debt market, this sponsor-friendly dynamic will not remain indefinitely. The private equity market is expected to continue to take full advantage of the greater availability, flexibility, pricing and borrower-friendly terms while it remains in the current European debt markets.