US Direct Loans Do Well After COVID-19 | White & Case LLP



  • Private debt fundraising in North America increased 15.8% in 2020 despite lower fundraising in other jurisdictions
  • The private debt default rate never exceeded 2% in 2020 and was lower than the default rates for high yield bonds and leveraged loans
  • Current private debt yields of 7% exceed high yield bonds and leveraged loans

After a volatile and difficult year, U.S. direct lenders entered 2021 with improved reputations and teams strongly positioned to fund new deals. But we cannot discuss the current direct lending to the United States without casting a slightly wider net for comparison.

According to data collected by Preqin and analyzed by McKinsey, global private debt fundraising (where direct loans represent the largest amount of capital) fell 6.7% to $ 124.4 billion in 2020, as COVID-19 has seen investors put new funds on hold. . The North American market, however, has resisted the global trend, with private debt fundraising up 15.8% year-on-year to $ 79.8 billion.

This growth in private fundraising is conclusive proof that the North American direct lending space has grown into a credible and established industry capable of operating through credit cycles.

Despite the disruption associated with the pandemic, private debt markets continued to benefit from the long-term regulatory trend following the 2008 global financial crisis, according to McKinsey. Regulatory changes put in place after the crisis limited traditional bank credit channels and gave non-bank direct lenders the opportunity to gain market share and expand their franchises. A prolonged period of low interest rates and an accommodating monetary policy also supported growth in the direct lending industry.

Private debt portfolios also appear to have been less affected by pandemic volatility. As private credit assets are not listed on a stock exchange and held in closed fund structures, they are less exposed to market volatility.

This idea is reinforced by a first quarter 2021 research note from the private market investment platform Adams Street, concluding that private debt default rates never exceeded 2% in 2020, while rates defaults on leveraged loans and high yield bonds were around 4% and 10%. respectively.

US investment manager Nuveen further notes that because the private credit investment market is illiquid, space managers have also taken a more conservative approach to credit risk. Unlike investors in high yield bonds and leveraged loans, who have the flexibility to trade underperforming assets as needed, private credit managers follow buy and hold strategies, which has helped them led to show a propensity to finance defensive and asset financing arrangements. light sectors.

In addition, private credit managers often align themselves with borrowers backed by private equity (PE) firms with specific industry / operational expertise, which adds a layer of downside protection.

Private debt funds, however, have not only proven effective in mitigating downside risk. The managers also continued to provide returns to investors. According to Adams Street, private debt funds have produced current average returns of around 7%, compared to average returns of 4.73% for high-yield bonds and 4.61% for leveraged loans.

According to Adams Street, private debt funds have produced current average returns of around 7%, compared to average returns of 4.73% for high-yield bonds and 4.61% for leveraged loans.

Perfect positioning

With the reopening of the U.S. economy, direct lenders have shifted their focus and resources to new transactions and are well positioned to continue to secure the flow of new transactions and deliver higher returns than other fixed income categories.

According to Nuveen, the potential pipeline of transaction opportunities for private debt managers looks promising. The ratio of dry powder held by private equity firms (the main users of private debt capital) to private debt funds is 5: 1. Since private market M&A transactions are typically structured with debt between 50% and 75% of total pro forma capitalization, the ratio of dry powder debt to dry powder PE should go between 1: 1 and 1: 4 before there is any risk of saturation of the private debt market. All of this means that the post-pandemic supply-demand dynamic still favors private debt managers.

Further, Nuveen’s analysis notes that while the COVID-19 slowdown is very different from other economic downturns, the private debt vintages launched in times of downturn have historically outperformed the other years, with 2001 and 2009 being both. best performing private debt years on record for Date.

The growth in private debt assets under management has also enabled direct lenders to compete for credit that would otherwise have gone into default in the syndicated loan or high yield bond markets.

Some direct lenders have the ability to digest credit up to US $ 1 billion or form loan clubs among themselves that can cover checks of up to US $ 3 billion.

Direct lending has been an attractive option for borrowers, especially PE promoters, due, in part, to the speed of execution of direct lending transactions and the fact that the pricing and other conditions applicable to these transactions. are not subject to change due to market flexibility. provisions.

Additionally, PE promoters appreciate the simplicity of working with a single or a small group of counterparties rather than a wide range of lenders in a leveraged loan syndicate.

Competition with the syndicated loan and high yield bond markets has meant direct lenders have had to tighten the pricing of their loans and, in some cases, lend on concessional terms, which until now has not been a good idea. characteristic of the documentation of direct loans in the midrange core.

The active selection of PE-backed loans and borrowers by direct lenders, the large amounts of liquidity at their disposal, and the resilience of their portfolios after the pandemic period, however, suggest that direct lenders are well positioned to continue to expand. their platforms and support increasingly larger tickets in the coming year.

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