Six reasons behind the rise of direct lending – Finance and Banking

Worldwide: Six Reasons Behind Direct Lending’s Rise to the Top

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The private debt market has grown in popularity in recent years as investors seeking higher yields adopt direct lending strategies. But why has it become the go-to financing solution for many institutional investors? Martin Reed, Head of Capital Markets – Americas explains.

Private debt funds primarily involved in direct lending are by no means newcomers to capital markets, but they are certainly one of the biggest on the playing field after record fundraising activity in 2021 .

Direct lending offers non-bank creditors, typically asset managers, the opportunity to make direct investments in middle-market companies – those companies generating between $50 million and $1 billion in annual revenue. Loans are a critical source of capital for businesses, as banks have continued to withdraw from traditional lending channels since the global financial crisis.

Funds focused on direct lending now represent a significant share of the private credit market, accounting for approximately 58% of capital raised worldwide (a record $112 billion) by credit funds in 2021.

So why is direct lending an attractive investment and what advantages does it offer over other financing solutions such as syndicated bank loans (BSL) and high yield bonds?

  • Direct lending offers asset managers higher returns than other credit investments such as BSL loans and bonds, but with less risk.

  • They offer better protection against rising interest rates because they have a shorter duration than fixed rate debt.

  • They do not lose value when interest rates rise. This is because they have floating rate coupons that increase based on the underlying benchmark rate associated with the transaction.

  • They carry the seniority on the privilege of the goods. Senior and subordinated loans are at the top of the cascade ahead of obligations on repayments in the event of default.

  • Direct loans offer greater protection to lenders because they are secured by the assets of the business. Because they have a higher priority than bonds, covenants in loan agreements place tighter restrictions on the company incurring additional debt, for example, and require companies to maintain ratios of indebtedness and coverage of specific interests which are regularly checked.

  • They offer lower potential losses in the event of default and have significantly higher recovery rates for BSLs and bonds.

Private debt success set to continue

The future looks bright for private debt funds. They were even able to escape the volatility of the pandemic largely unscathed. Indeed, private credit assets are not listed on the stock exchange and being held in closed structures, they are less exposed to the capricious nature of the market. They now look set to continue their success through 2022 and the funds are focusing their resources on securing new deal flow.

Like White & Case LLP highlighted in a recent articleaccording to Nuveen, “The potential pipeline of deal opportunities for private debt managers looks promising. The ratio of dry powder held by private equity firms (the primary users of private debt capital) to private debt ratio is 5:1 As private market M&A deals are typically structured with debt between 50% and 75% of total pro forma capitalization, the dry powder ratio of debt to PE dry powder should go between 1:1 and 1:4 before there is a risk of private debt market saturation All of this means that post-pandemic supply and demand dynamics still favor managers of private debt.

Private debt managers obviously have the capital in their arsenal to jump into new financings, execute them quickly, and deliver superior returns.

It also means that there will be an increased need for service providers, like Ocorian, to step in as administrative agents.

Hiring specialist loan officers can increase deal flow and reduce risk

Specialist independent lending agency providers are a key entity in the efficient execution of direct lending and have become an increasingly popular service provider in the private debt space. Lenders can reduce their administrative costs, speed up KYC procedures and receive tailored and unbiased solutions for their transactions by engaging with an independent agent.

Borrowers can also benefit from having a professional, independent loan officer manage their loans, as they provide an efficient and reliable solution to transaction disputes and administrative issues.

Give your transaction the best chance of success

At Ocorian, we provide full loan agency services, including as an administrative agent, facility agent or security agent in major financial centers around the world, including the US, UK and Northern Europe.

Our global credit agency teams, including our subsidiary Nordic Trustee – the leading credit agency provider in the Nordics – are currently involved in over 100 private debt financings covering all types of structures.

We work with some of the biggest and best. Leading international private equity firms and international private debt asset managers choose us as their administrative partner for their direct lending mandates.

Our credit bureau teams are made up of experienced banking and finance lawyers and credit professionals who have worked through complex debt scenarios and credit cycles. They serve as a seamless extension of private debt funds’ internal transaction teams, providing oversight of loan portfolios and providing real-time data and dashboards for bespoke financial, management and investor reporting. All of our private debt assignments are embedded on our modern in-house developed loan administration platform and are tailored specifically to the needs of our private debt clients.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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