By Will Caiger-Smith and Bill Weisbrod
In the riskier depths of the corporate credit markets, the traditional investment banking model – in which the storied firms use their networks and expertise to connect companies with lenders – has come under attack. And some bankers are fighting back.
The invaders are so-called direct lenders, specialized credit funds that typically make loans to smaller companies but lately have been writing bigger checks. These firms’ assets have ballooned in size over recent years, as yield-starved investors search for juicier returns.
In the past month alone, these firms have enabled several companies—including Ahead DB, Risk Strategies, and Parts Town—to cut out the middle-man, by negotiating sizeable loans directly with the borrower rather than through investment bankers, sources told Debtwire.
One reason these lenders are making bigger loans is their breakneck growth: they’re sitting on $278 billion of assets under management, with some $104 billion yet to be deployed in new investments, according to research firm Preqin.
But it’s also because traditional leveraged loan investors—the institutional asset managers that banks distribute leveraged loans to in so-called syndications—are becoming warier of companies with low credit ratings, amid fears of an impending recession.
This is making it more expensive for risky companies to borrow money. The gap between new issue loan spreads from issuers with single-B and double-B credit ratings has widened to 204bps so far this quarter, from 142bps in the final quarter of last year.
As direct lenders exploit this disruption, investment bankers have two choices: retrench to the safer loans traditional investors will still buy, or stand their ground and duke it out with their new competitors. Many bankers are choosing the second option, sources said.
“It’s partly about protecting our turf from a competitive standpoint,” said a syndicate banker. “Each situation is unique, but while direct lending is becoming a more viable option, some of those borrowers could be better off in the syndicated market.”
Recent deals show this resistance in action. Direct lenders were chomping at the bit to fund Shields Health’s leveraged buyout and CityMD’s acquisition of Summit Medical, but in each case Credit Suisse fought back and won the coveted lead arranger spot for a traditional syndication, sources said.
Likewise, UBS persuaded refrigeration and air conditioning company CoolSys and alternative asset manager Vida Capital to opt for publicly syndicated deals. Both transactions could easily have been placed entirely with private lenders, two sources told Debtwire.
In some cases, borrowers prefer the extra flexibility banks can offer. Direct loan agreements typically include limits on how much extra debt companies can raise—for example to fund future acquisitions—whereas publicly syndicated deals often don’t.
However, in recent months banks have struggled to place such loans with investors. This has led them to spend longer workshopping deals with favored buyers before officially launching them into syndication—but even so, they can’t escape the allure of direct lenders.
In August, direct lending firm Golub Capital funded Blue River PetCare’s buyout, displacing a loan Bank of America was preparing to syndicate. And in October, direct lenders helped inject momentum into a struggling loan syndication for Cooper’s Hawk Winery, also led by BofA, two sources told Debtwire.
While direct lenders typically charge higher interest rates, that gap is closing, sources said. And because rates are negotiated with the borrower upfront, the premium may be worth it to avoid a troubled syndication.
“You really don’t know where [a low-rated loan] will end up in syndication anymore, whereas with a direct deal you have that line of sight,” said another banker. “[Direct lenders] are true pricing competitors now.”
Will Caiger-Smith is an associate editor at Debtwire covering leveraged finance. He can be reached at email@example.com.
Bill Weisbrod is a senior reporter at Debtwire Middle Market covering leveraged finance. He can be reached at firstname.lastname@example.org.