LONDON, Jan 9 (LPC) - Sponsors are imposing stronger restrictions in loan agreements to limit a direct lender’s ability to offload debt to third parties, as the credit cycle advances and fears of a downturn increase, banking sources said.
Sponsors are implementing tough transfer restrictions and reducing market liquidity, to ensure access to unfunded facilities including capital expenditure and acquisition lines.
“Sponsors are getting nervous about downside risks and are restricting transferability in their loan agreements. Sponsors want to ensure they can access their capex facilities to make acquisitions,” said Stuart Brinkworth, head of leveraged finance Europe at law firm Mayer Brown.
Although transfer restrictions have been prevalent in Europe’s syndicated loan market for some time, it is now migrating to Europe’s direct lending market.
Historically, syndicated loan investors were able to sell paper to third parties, then sponsors clamped down to prevent distressed funds buying up debt via white lists of acceptable buyers. It went a stage further in 2016 when sponsors blocked any sale without their consent even in the event of a default.
Many feel the adoption of such a drastic measure in an already illiquid mid-market space is unnecessary, as direct lenders operate differently to lenders in the syndicated market.
“Direct lenders are far more credit focused compared to investment banks arranging financings and determined to hold the debt longer than arranging banks, so they have a large chunk of skin in the game. Pushing for large cap terms on the basis of what’s been accepted in the syndicated market is the wrong comparison,” said Annette Kurdian, banking and finance partner at Linklaters.
PUTTING MONEY TO WORK
While direct lenders provide funded debt to borrowers in various forms including unitranche and senior loans, banks have traditionally provided all unfunded facilities to borrowers.
However flooded with cash, direct lenders began in force in 2019 to offer unfunded acquisition and capital expenditure lines to borrowers, in a bid to put more money to work.
Acquisition funding has become increasingly important for private equity firms as they opt for buy-and-build strategies to grow portfolio companies, in a weak environment that does not support high valuations and full exits.
While banks have tried and tested long term relationships with sponsors, many direct lenders have yet to go through a full credit cycle and it is unclear how direct lenders will act when companies start to underperform.
With a greater percentage of their portfolios now reliant on funding from direct lenders, sponsors have tried to lock these lenders into holding their debt.
While many direct lenders are unhappy with tighter transfer restrictions, they are unwilling to push back against the request, given the amount of money in the market and competition from other lenders.
The main focus is credit selection, ensuring that borrowers provide a good credit matrix.
“Private debt funds prefer good credit with bad documentation rather than bad credit with good documentation,” a lawyer said.