NEW YORK, Aug 24 (LPC) - The competitive dynamics that have defined US middle market lending in 2018 so far are expected to persist after Labor Day, as the market gears up and lenders and investors battle to win mandates and hold onto existing portfolio assets.
Middle market lenders are optimistic that dealflow will pick up again in September after a lull in the second half of August, when few deals launched. Lenders and investors are preparing to work aggressively to win those deals and protect existing assets and incumbent arranging positions, three middle market participants said.
“Everybody wants to be a lead. That’s how you control your destiny and make your shop significant and relevant to sponsors,” a middle market investor said, adding that the ability to commit capital and hold in size is critical.
Intensifying competition amid an influx of capital has seen middle market lending move away from syndicated deals towards club deals that only require a handful of investors, which means that capital providers need to be the first call for sponsors.
In the first half of this year, twice as many middle market buyouts were financed by direct lenders versus traditional syndicated loans, LPC data shows.
“If a sponsor takes three lenders to the dance, you want to be in that rotation,” a second middle market investor said.
This dynamic, combined with a borrowers’ market where demand exceeds supply, naturally benefits larger, more established platforms that can compete more aggressively on price or leverage in order to hold onto mandates and portfolio assets.
One incumbent lender inked an all-senior deal with 7.25x total leverage at pricing of 525bp over Libor recently, the first investor said. Existing lenders were unable to join the new capital structure at that price, but the lender held the entire transaction and brought in only one participant.
“If you know a business and know it well, you are willing to defend your portfolio,” the first investor said.
Existing platforms are also continuing to build out teams to expand direct lending offerings and new platforms are still being formed, which means appetite is not waning as yet.
Earlier this summer, Alcentra, an alternative fixed income specialist for BNY Mellon Investment Management, announced the expansion of its US direct lending team, bringing on board Suhail Shaikh and Peter Glaser as managing directors and co-heads of US direct lending based in New York.
Middle market sponsored volume for syndicated and direct lending of US$95.5bn in the first half of 2018 is on track to top 2017’s combined tally of US$151bn, the data shows.
Optimistic market participants expect a steady flow of deals in September, as a benign macroeconomic environment and solid demand from private equity buyers contribute to healthy pipelines.
M&A activity is expected to dominate, as many of the deals that could be refinanced and repriced were done earlier in the year.
There is plenty of sponsor capital to invest and sellers are trying to evaluate those opportunities, a third middle market lender said. “Generally speaking there is a clear runway for the back third of the year,” he added.
There could be a pause in supply around the November mid-term elections as sponsors and issuers wait to see what a possible change in control in the US House of Representatives could mean from a policy perspective.
Demand is expected to remain strong as excess capital seeks high-quality paper. “High-quality deals remain highly sought after,” the second lender said.
Pricing has mostly stabilized compared to earlier in the year, as traditional middle market lenders have held the line at 400bp over Libor for a first-lien institutional term loan, but spreads could potentially come under pressure again if demand ramps up even further.
Middle market institutional term loans are yielding 7.06% so far in the third quarter, up from 6.64% in the second quarter and significantly higher than the 5.95% seen in the third period of last year. Leveraged loans, which are floating-rate instruments, are benefitting from rising Libor rates as well as a flattening in spreads over the benchmark.
Despite improving yields, market participants would not object to some volatility to take the heat out of the market.
“The market is waiting for a speed bump,” the second lender said, “though not a pothole.” (Reporting by Leela Parker Deo Editing by Tessa Walsh and Michelle Sierra)