U.S. Direct Lending Market Won’t See ‘Summer Slowdown’

(Bloomberg) -- The U.S. direct lending market, approaching the $1 trillion mark, isn’t facing a summer slowdown due to a robust pipeline of sponsor-backed deal activity.

“We see consistent deal flow and pitch activity remains strong and very healthy and that means they have a nice backlog,” said Thomas Aronson, head of originations at middle market lender Monroe Capital. “I know that there’s still money that guys want to put to work in the private equity community. Middle market lending still continues to remain strong and healthy.”

One potential snag would be any escalation in the trade spat, which may put a damper on certain sectors. “So far it hasn’t been a significant issue-- I haven’t seen a lot of transactions falter because of the tariff activity and people aren’t looking at it as having a long term impact, but it’s something to watch,” Aronson said.

Pricing for middle market deals has remained steady over recent months, Aronson said. A typical first-lien deal for a company with $20 million or more in Ebitda is usually priced at 450 to 600 basis points over Libor. For companies with $5 million to $20 million in Ebitda, first liens are typically priced at 550 to 700 basis points over Libor.

“What you continue to feel pressure for are in the other asks in the credit documents that private equity sponsors are pushing for,” he said. Those include covenant cushions, flexibility for future acquisition and dividends.

Middle market deal activity in May was particularly active in the health-care and technology sectors -- and mainly earmarked for buyout or acquisitions. Last month, Barings said it arranged a credit facility that backed the recapitalization of email marketing automation platform CM Group and the acquisition of digital marketing company Vuture. Twin Brook Capital Partners, served as administrative agent on an $84.5 million financing backing Naylor Association Solutions’s purchase of digital marketing and event company TechMedia.

In May, Antares Holdings LP and Bain Capital Credit provided a $270 million facility to back Frazier Healthcare Partners’ acquisition of Comprehensive Pharmacy Services. TPG Sixth Street Partners said it provided Clovis Oncology Inc. with $175 million in financing for expenses related to a clinical trial.

BDC Performance

Performance for business development companies, which provide loans to small- and medium-size borrowers, has flattened out after a strong run to start 2019. As of May 31, BDCs have returned 14.63%, according to the Wells Fargo Business Development Company Index. That compares to a 5.49% gain for leveraged loans and 7.49% return for junk bonds through May 31. Last month, both leveraged loans and high-yield bonds saw their worst monthly performance since December.

U.S. Direct Lending Market Won’t See ‘Summer Slowdown’

Much of the bounce at the start of the year was recouping from fourth quarter credit spread widening, said Mitchel Penn, an analyst at Janney Montgomery Scott LLC. The market is trying to digest the effect of an increase in debt to equity levels that took effect last year, and that is being implemented across the industry. A proposed rule change that would allow ETFs and mutual funds to own more than 3% of a BDC is another change on the horizon that may create quite a bit of demand.

“The technicals for BDCs are very good right now,” Penn said. “Credit is pretty good and they’re levering up. That’s why I think over the next year or two they’re in pretty good shape as long as we don’t get an economic slowdown.”

©2019 Bloomberg L.P.

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