Evolution of private debt market provides deal-makers with more flexible financing options
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For well-rehearsed reasons, both the syndicated loan and high-yield markets had little appetite for underwriting new debt from Q2 2022 onwards. Volumes for both these products were significantly reduced both at year end 2022 and year-to-date at the end of August 2023 compared to the period before Russia’s invasion of Ukraine.
During that period when broadly held instruments were hard to come by, private debt, already a popular and established source of capital, was presented with an opportunity to step up and bridge the funding gap left by inaccessible syndicated markets.
The most immediate and obvious opportunity was in the sphere of senior secured debt, where underwriters sitting on large positions were able to turn to private debt to de-risk their positions. There were incidences of private debt funds taking out underwriters in full in the early stages of the syndicated market slowdown, as well as assuming the role of anchor investor, taking a significant chunk of debt off the table and leaving a more manageable amount for underwriters to get away in the market. As the syndicated market reopens, we expect to see this sort of hybrid syndication arrangement persist on some credits.
Still in the senior secured lending space, sustained successful fundraising by private debt funds (until a marked drop off this year) and more frequent club deals in this area facilitated larger deal sizes and an opportunity to increase market share in the large cap space (e.g. a club of direct lenders provided approximately £1bn of debt to Civica, a Partners Group portfolio company, to refinance its existing loans).
Private debt funds support run of P2P deals
We also saw private debt funds being called on to support the summer run of public-to-private deals, where previously an underwritten syndicated solution would have been the preferred route. While the impact of the recent drop-off in fundraising remains to be seen, we don’t see the trend towards more frequent club deals reversing. The traditional bilateral take-and-hold strategy of funds has also evolved in some cases to include warehousing of private debt in advance of a co-ordinated sell-down to other funds.
However senior secured debt isn’t the only option for private equity sponsors turning to private debt funds in search of capital. There has also been increased deployment of junior capital solutions such as holdco PIK financings and single asset NAV (net asset value) facilities. These subordinated debt classes offer much-needed liquidity to support the underlying portfolio company’s capital needs, but sit higher up in the corporate structure so that they don’t affect leverage limitations in the senior debt financing.
We are also seeing more private equity sponsors seek to leverage their portfolios to gain liquidity by putting finance in place at the fund level. Factors driving this increase include portfolio company liquidity needs (where a company can’t attract further leverage on its own); a challenging exit market that is forcing private equity sponsors to consider continuation funds to provide exit or rollover options to investors; and pressure from those investors to return contributions ahead of new fundraises.
NAV financings (in the form of secured or unsecured loans, private CLOs and other structured solutions), along with preferred equity solutions, can provide the additional pools of capital private equity sponsors currently need. As with senior secured debt, as the size of facilities has grown we have seen club deals emerge in the portfolio NAV space, where previously bilateral arrangements were the norm.
As product selection evolves, so does the universe of direct lenders
In addition to the variety of products available from private debt funds, we have also seen the universe of direct lenders itself evolve. New participants are entering the fray, and established funds are seeking to better serve the range of capital needs of their private equity sponsor clients by diversifying their strategies.
For example, sovereign wealth funds and family offices which have to date featured as limited partners are now entering the market directly by way of co-investment rights, or in some cases on a standalone basis. In the NAV space, providers now include specialist fund finance lenders (typically funds), private debt funds, hybrid debt/equity funds, and structured products teams at financial institutions.
So where does this leave private equity sponsors in search of leverage and liquidity? The landscape they now have to navigate in search of debt finance looks more like a Venn diagram of intersecting products, providers, prices and terms than a series of distinct pockets of capital. It’s complex, for sure, but it offers the opportunity to design a bespoke debt stack that more closely matches the needs of their portfolio in a challenging environment.