q4 2020 european direct lending perspectives

Creditflux

Q4 2020

European Direct Lending Perspectives

Going for goldDirect lending set for a big year in 2021

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11 March 2021 13:00 GMT

Creditflux DL Book now Mar21 - A4 ammended.indd 1Creditflux DL Book now Mar21 - A4 ammended.indd 1 23/02/2021 16:11:1223/02/2021 16:11:12

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Contents

Editor’s letter: Direct lenders set for a bumper 2021 4

League tables: Debtwire Par’s exclusive rankings 5

Data analysis: Direct lending figures at your fingertips 9

News: Selected stories from Debtwire and Creditflux 12

Fundraising analysis: Direct lending shows its resilience 14

Feature: 2020 review: When will the real test begin? 17

Survey: Direct lending new year euphoria 20

Feature: 2021 outlook: The dust is yet to settle 24

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Direct lenders will dance as long as the music plays

Welcome to the ninth edition of the Creditflux and Debtwire European Direct Lending Perspectives (EDLP). In this issue, we look at how direct lenders exceeded early-2020 expectations and bounced back with aplomb to set themselves up for a strong 2021

Mariana ValleHead of leveraged

finance and direct

lending coverage,

co-deputy editor

Europe

The direct lending market finished 2020 with a bang, defying all early-year expectations when the pandemic began and debt providers became nervous about deploying. Fast forward several months, and many funds will tell you Q4 was their best-ever quarter.

Direct lending issuance totalled €15.8 billion in 2020, a 13% decline from 2019’s €18.2 billion. But issuance in the final quarter was strong, reaching €4.13 billion across 124 deals, according to Debtwire Par data.

Private debt providers are, in fact, so upbeat that 59% of respondents to our yearly survey said they expect coronavirus disruption to have only a minimal impact on their fundraising efforts in 2021, with another 32% saying they expect no, or indeed, a positive impact. This is in stark contrast to last year’s fundraising figures, when just €16 billion was raised – a 56% year-on-year drop, according to Debtwire Funds Data. But 2021 is likely to make up for lost time, with 44% of respondents expecting €20-30 billion to be raised this year, another 22% expecting €30-40 billion and a further 22% anticipating €40-50 billion.

Despite the wobbles of covenant problems in portfolios, some level of debt restructurings and intermittent periods of economic instability caused by recurring national lockdowns, our survey reveals that the market expects 2021 to be a good year for direct lending. Almost 70% of respondents believe deployment will increase this year.

Sporadic lockdowns in the UK and continental Europe, difficulties over vaccine deployment and emerging variants of COVID-19 are certainly factors that could hamper activity in 2021, but direct lenders will continue to dance as long as the music plays.

M&A in Q1 2021 is proving fruitful so far, which is likely to lead to healthy issuance in the early part of this year. Inflated asset prices are also making way for more pre-emptive approaches from private equity (PE) firms, which in turn is creating more opportunities for direct lenders, given their ability to act quickly and quietly.

In this edition, we look back over 2020 to draw expectations for the year ahead. You will find the usual deal data, league tables, fundraising data and news, as well as features on pent-up demand and how those in the direct lending market are preparing to brush themselves off and bounce back better than ever.

Fast forward several months, and many funds will tell you Q4 was their best-ever quarter.

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League tables

Debtwire Par’s exclusive league tables show the top lenders in Europe in the key regions and for mid-market and senior debt

Research by Darren MaharajManager of

global fixed

income data

2020 FYE EMEA Direct Lending League Table (Senior & Subordinated)

2020 FYE EMEA Direct Lending League Table (Senior-only)

Rank Direct lender # of deals

% share

1 Ares 51 10.8%

2= Barings Direct Lending

25 5.3%

2= Pemberton 25 5.3%

4 Arcmont AM 22 4.7%

5 Kartesia 21 4.4%

6 Alcentra 20 4.2%

7= Bridgepoint Credit

19 4.0%

7= CIC Private Debt

19 4.0%

9= IDInvest 18 3.8%

9= Tikehau 18 3.8%

11= BlackRock 17 3.6%

11= CVC Credit 17 3.6%

13 Apera AM 16 3.4%

14 Permira 13 2.8%

15= Ardian 12 2.5%

15= LGT Private Debt 12 2.5%

17 Muzinich Private Debt

11 2.3%

18 Ture Invest 10 2.1%

19 DunPort Capital 9 1.9%

20= Bright Capital 8 1.7%

20= Cordet Capital 8 1.7%

20= HF Private Debt 8 1.7%

20= Shard Credit 8 1.7%

24= Crescent Capital

7 1.5%

24= Investec 7 1.5%

Rank Direct lender # of deals

% share

1 Ares 48 11.1%

2 Barings Direct Lending

25 5.8%

3 Pemberton 24 5.6%

4 Arcmont AM 22 5.1%

5 Kartesia 20 4.6%

6= Alcentra 19 4.4%

6= Bridgepoint Credit

19 4.4%

8 BlackRock 17 3.9%

9= Apera AM 16 3.7%


9= IDInvest 16 3.7%

9= Tikehau 16 3.7%

13= CIC Private Debt

13 3.0%

13= Permira 13 3.0%

15 LGT Private Debt

12 2.8%

16 Muzinich Private Debt

11 2.6%

17= Ardian 10 2.3%

17= Ture Invest 10 2.3%






24= Crescent Capital

7 1.6%

24= Investec 7 1.6%

26 Capital Four 6 1.4%

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2020 FYE EMEA Direct Lending Mid-market League Table (<€150m) (Senior & Subordinated)

2020 FYE EMEA Direct Lending Large-cap League Table (>€150m) (Senior & Subordinated)

2020 FYE UKI Direct Lending League Table (Senior & Subordinated)

2020 FYE DACH Direct Lending League Table (Senior & Subordinated)

Rank Direct lender # of deals % share

1 Ares 27 7.0%

2 Barings Direct Lending 20 5.2%

3= Alcentra 19 4.9%

3= Kartesia 19 4.9%

5 IDInvest 17 4.4%

6= Apera AM 16 4.1%

6= Arcmont AM 16 4.1%


9 CIC Private Debt 15 3.9%

10= Bridgepoint Credit 14 3.6%


10= Tikehau 14 3.6%

13 BlackRock 13 3.4%

14 LGT Private Debt 12 3.1%

15 Muzinich Private Debt 11 2.8%

16= Ardian 10 2.6%


18= DunPort Capital 9 2.3%


1 Ares 24 28.6%

2 Pemberton 9 10.7%

3 Arcmont AM 6 7.1%


4= Barings Direct Lending 5 6.0%

4= Park Square 5 6.0%

7= HPS 4 4.8%

7= BlackRock 4 4.8%

7= CIC Private Debt 4 4.8%

7= Permira 4 4.8%

7= Tikehau 4 4.8%

12= Apollo GM 3 3.6%

12= Bain Capital Credit 3 3.6%


12= Deutsche Bank Direct Lending

3 3.6%

12= GS Private Capital 3 3.6%

12= KKR 3 3.6%


1 Ares 32 17.7%

2 Pemberton 13 7.2%


4= Alcentra 10 5.5%

4= Apera AM 10 5.5%






11 Kartesia 7 3.9%


12= Permira 6 3.3%


14= Investec 4 2.2%

16= HPS 3 1.7%

16= KKR 3 1.7%

16= Muzinich Private Debt 3 1.7%

16= Shawbrook 3 1.7%






5= Apera AM 4 5.2%

5= Ares 4 5.2%


8= Ardian 3 3.9%

8= Capital Four 3 3.9%


11= Akquivest 2 2.6%

11= Alcentra 2 2.6%




11= Hayfin Capital 2 2.6%

11= IDInvest 2 2.6%

11= Investec 2 2.6%


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ue tables

2020 FYE France & Monaco Direct Lending League Table (Senior & Subordinated)

2020 FYE Benelux Direct Lending League Table (Senior & Subordinated)

2020 FYE Southern Europe Direct Lending League Table (Senior & Subordinated)

2020 FYE Nordic Direct Lending League Table (Senior & Subordinated)


1 CIC Private Debt 19 24.4%

2 IDInvest 14 17.9%

3 Tikehau 10 12.8%


5 Ardian 5 6.4%

6= BlackRock 4 5.1%


6= Kartesia 4 5.1%

9= Alcentra 3 3.8%



12= Ares 2 2.6%

12= CAPZA Private Debt 2 2.6%



12= Siparex 2 2.6%

17= Access Capital 1 1.3%

17= Actomezz 1 1.3%

17= Andera Partners 1 1.3%

17= Apera AM 1 1.3%


17= Hayfin Capital 1 1.3%

17= ICG 1 1.3%



1= Kartesia 6 13.3%

1= Oquendo Capital 6 13.3%

3 Tikehau 4 8.9%

4= Anthilia Capital 3 6.7%


4= Azimut 3 6.7%


4= Resilience Partners 3 6.7%


9= Equita Capital 2 4.4%

11= Alantra 1 2.2%

11= Apollo GM 1 2.2%

11= Banca Finanziaria 1 2.2%



11= CAPZA Private Debt 1 2.2%

11= CIT Group 1 2.2%

11= Green Arrow 1 2.2%


11= H&A Global IM 1 2.2%

11= HIG Capital 1 2.2%

11= IDInvest 1 2.2%


11= Och-Ziff Capital 1 2.2%


1 Ture Invest 9 22.0%

2 Ares 8 19.5%



3= Permira 4 9.8%

6= Ardian 2 4.9%

6= Crescent Capital 2 4.9%

8= Alcentra 1 2.4%





1 2.4%



1 Ares 5 11.1%

2= Alcentra 3 6.7%



2= Dexteritas IM 3 6.7%





6= Dutch Mezz Fund 2 4.4%

6= Kartesia 2 4.4%

6= Neos Direct Lending 2 4.4%

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2020 FYE EMEA Healthcare Direct Lending League Table (Senior & Subordinated)

2020 FYE EMEA Business & Related-services Direct Lending League Table (Senior & Subordinated)

2020 FYE EMEA Financial Services Direct Lending League Table (Senior & Subordinated)

2020 FYE EMEA Western Europe TMT Direct Lending League Table (Senior & Subordinated)


1 Ares 7 11.5%

2 Kartesia 6 9.8%

3= Ardian 5 8.2%


5= Apera AM 4 6.6%

5= Pemberton 4 6.6%



7= IDInvest 3 4.9%

7= Tikehau 3 4.9%

11= Alcentra 2 3.3%





2 3.3%



17= Azimut 1 1.6%


1 Ares 14 11.9%


3 Arcmont AM 9 7.6%

4 CVC Credit 8 6.8%

5= Alcentra 6 5.1%

5= BlackRock 6 5.1%


5= IDInvest 6 5.1%

9= Apera AM 5 4.2%

9= Kartesia 5 4.2%

11 Shard Credit 4 3.4%





12= Investec 3 2.5%




1 Ares 13 26.0%

2 Alcentra 6 12.0%

3= Apollo GM 3 6.0%






5= Dexteritas IM 2 4.0%


5= Investec 2 4.0%

5= KKR 2 4.0%

5= Pemberton 2 4.0%

5= Permira 2 4.0%

5= Tikehau 2 4.0%


17= Apera AM 1 2.0%

17= Ardian 1 2.0%



1 Ares 10 9.1%

2 Arcmont AM 8 7.3%

3 BlackRock 7 6.4%

4 Tikehau 6 5.5%


5= Kartesia 5 4.5%

5= Pemberton 5 4.5%


9= Apera AM 4 3.6%


9= IDInvest 4 3.6%

9= Permira 4 3.6%

13= Alcentra 3 2.7%

13= Ardian 3 2.7%


13= Pride Capital 3 2.7%




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ata analysis

Debtwire direct lending data

Direct lending issuance jumps up in Q4 following a lacklustre pandemic performance

Research by Ben WatsonMarket analyst

Debtwire Par

no. DL unitranches no. DL non-uni

Num

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of d

eals

Unitranche volum

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DecNovOctSepAugJulJunMayAprMarFebJanDecNovOctSepAugJulJunMayAprMarFebJanDecNovOctSepAugJulJunMayAprMarFebJan0

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Total volume of direct lending activity

2018 2019 2020

Number of unitranches vs unitranche volume

No. MM deals No. LC deals

Num

ber

of d

eals Volum

e of deals

0

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20

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Q4Q3Q2Q10.0

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Vol. LC dealsVol. MM deals

Large cap vs mid-market unitranche Use of proceeds

Dealmaking creates bedrock of issuance

M&A activity buttressed direct lending issuance over the course of 2020, averaging €2.4 billion per quarter. Refinancing was more variable. That said, the figure is heavily skewed by the largest deal of the year – UK insurance broker Ardonagh’s €2.27 billion direct lending facility.

Consistent unitranche activityThe troubled waters of 2020 were well navigated by direct lenders, with unitranche issuance totalling €10.8 billion for the year. Even while broadly syndicated loans were absent in April and generally struggled for the remainder of Q2, large cap (above €150 million debt) unitranche volume surged to more than €3 billion. Over the year, mid-market unitranches maintained a solid and stable performance, reaching a sum of €3.5 billion and ending on a high – 34 deals worth €500 million were completed in December.

2020 marked by opportunistic issuanceDirect lending issuance totalled €15.8 billion in 2020, a 13% decline from the previous year’s €18.2 billion. Under the circumstances, however, the final tally augurs well for the direct lending market. Deals came in ebbs and flows throughout the year during the intermittent periods of favourable financial condi-tions, which resulted in volumes from the three months of March, June and September accounting for almost half of the issuance for the year overall. In Q4, €4.13 billion was raised across 124 deals, marking something of a return to a more even level of activity. A total of 424 deals were completed over 2020 and, due to the dip in the average size of the facilities, this compares even more favourably to 2019 than the overall debt total. Unitranches accounted for just under 60% of direct lending issuance over the course of the year, in line with historical averages.

M&A Recap & Refi Other

€ b

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Sub-regional unitranche distribution

Sectoral issuance

Dea

l val

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€b

n) Num

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MM direct lending (€bn) Other mid-market (€bn) No. direct lending MM deals Total no. MM deals

0

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4Q3Q2Q1Q4Q3Q2Q1Q4Q3Q2Q1Q4Q3Q2Q1Q2017 2018 2019 2020

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UK issuance’s dominance still unrivalledThe distribution of direct lending deals per region was relatively stable, with noticeable trends of increasing DACH issuance (82 deals completed), while French direct lending marginally declined to 18% of issuance with 91 deals. The UK continued its dominance in the market with €6.56 billion in issuance over 187 deals in 2020.

Financial sector fills in gap left by TMTLooking past the small contraction to overall issuance in 2020, the TMT sector saw the most significant change in proportional issuance, dropping to under €2 billion – less than half the €4.5 billion raised in 2019. The financial services sector expanded over 2020 to represent 26% of issuance. Exclud-ing the landmark direct lending deal from Ardonagh, the healthcare sector rose to lead activity by sector with €2.26 billion, comprising 17% of issuance.

7%

34%

11%

13%

11%

24%

UKI DACH France Nordics Benelux Southern Europe

6%

39%

16%

9%

9%

21%

9%

38%

17%

8%

10%

18%

2018 2019 2020

3%

2%3%

5%7%

20%

6% 9%

17%

8%

2%

32%

Chemicals & industrials Consumer & retail Financial services Gaming & leisure Healthcare

Manufacturing TMT All other Power & utilities

11%

8%25%

16%

1%

25%

9%

8%

6%

14%

2%

30%

14%

17%

2018 2019 2020

Direct lending portion of mid-market declinesWhile direct lending continued steadfastly, the traditional portion of the mid-market maintained its lead in issuance over direct lending that was gained in early 2019. The €5.03 billion of direct lending issuance raised in 2020 was handily surpassed by the €13.2 billion elsewhere in the mid-market space. Mid-market direct lending now represents just under 30% of total mid-market volume, compared to 45% in 2017, 48% in 2018 and 42% in 2019.

Mid-market volume vs number of deals

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Paul Hastings is a market leader in global private credit funds,

advising on the structuring and implementation of cross-

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and experience in our team enables us to provide technical

and commercial advice to meet the needs of sophisticated

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funds in the credit space through our international network.

We believe that the depth and breadth of expertise that

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For further information, please contact

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Direct_Lending_Report_Ad_4c_210x297mm_092319.indd 1 9/23/2019 11:04:13 AM

EDLP_Q4 2020_Book_V1_AT.indb 11EDLP_Q4 2020_Book_V1_AT.indb 11 01/12/2020 15:14:5101/12/2020 15:14:51

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CIC launches CLO-like loan fund Crédit Industriel et Commercial (CIC) is looking to raise €300 million for a European senior debt fund. CIC European Large Cap Senior Debt Fund 2 will invest in PE-backed loans to companies with €100 million-€500 million EBITDA.

The fund follows a similar strategy to its predecessor, CIC ELCF 1, which launched in 2017, also at €300 million, and which has invested in 80 companies. Given the emphasis on large-cap loans and granular portfolio composition, the fund’s asset pool is akin to that of a typical European CLO. Steve Dunn, head of private debt for CIC’s London branch, is lead portfolio manager.

In addition, CIC says it has so far raised €340 million for CIC Mezzanine & Unitranche Financing 5, a vehicle launched late last year. It will invest in French companies and target mezzanine and unitranche debt.

Alantra buys stake in French direct lender Alantra has acquired a 49% stake in European mezzanine and junior private debt manager Indigo Capital, which the firm says will consolidate its position in the French sponsorless market and accelerate its growth in Italy

and other European geographies. Paris-based Indigo invests in SMEs in Europe with revenue between €20 million-€300 million through private bonds and preferred equity.

Alantra says the acquisition will strengthen its bid to become a “leading pan-European diversified asset manager” through direct investments, fund of funds, co-investments and secondaries. It plans to offer these solutions across PE, active funds, private debt, infrastructure, real estate and venture capital. The move follows Alantra’s incorporation of Grupo Mutua as its strategic partner.

Direct lending’s ready to blossomEuropean direct lending fundraising slumped year on year, with no final closes held in Q3. But market participants point out there is a more positive story not reflected in this dour picture.

The fundraising total is a big drop from Q3 2019, when Creditflux reported that five managers held final closes and raised €10.6 billion. These included mega-funds Alcentra European Direct Lending Fund III (€5.5 billion), Pemberton European Mid-Market Debt Fund II (€3.2 billion) and Barings European Private Loan Fund II (€1.5 billion).

But Creditflux’s Funds Data reveals more managers held first closes in Q3 as they sought to deploy capital amid coronavirus volatility. Ten European direct lending funds amassed €10.12 billion in first closes, including: Ares’ fifth fund in its series Ares Capital V (€6.97 billion); Pemberton Asset Management’s inaugural senior loan fund (€900 million); Capital Four’s Private Debt III – Senior Lending (€500 million); Capza’s 5 Flex Equity (€450 million); and Artemid Senior Loan III (€400 million). In Q3 2019, seven funds held first closes but brought only one-tenth of the capital (€1.03 billion) to the market.

Many fund managers originally outlined final closes in Q1 and early Q2 but pushed these back to the end of the year. This was to accommodate investors wishing to wait for greater visibility on COVID-19.

Despite the low headline figures, sources say fundraising remains healthy and highlight that declining volume is a feature across all alternative markets.

Direct lending news in briefCreditflux and Debtwire report on the biggest stories in the world of direct lending. Breaking exclusives on funds, launches, strategies and hires make these must-have services for a market hungry for news. The stories here are just a small sample of what is on offer

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EQT lines up debt funds for SaaS acquisitionEQT is finalising a group of private debt providers to part-finance its buyout of German software-as-a-service (SaaS) provider thinkproject, which focuses on construction intelligence. The sponsor has lined up Bridgepoint Credit, Goldman Sachs PIA, Northleaf, Park Square/SMBC JV and Partners Group to provide a unitranche and acquisition facility package, according to four sources familiar with the situation.

The financing is expected to comprise a €177.5 million unitranche and a €60 million acquisition facility provided by the funds, as well as a small RCF from Commerzbank, one of the sources said.

The competitive financing process saw funds pitch as high as 7x and banks 5x-5.5x. EQT acquired a majority stake in thinkproject for an EV multiple not far from 30x. The asset was marketed off €30 million EBITDA including new business, or €24 million without.

New

s

Club deals lose ground as banks turn up caution With M&A having picked up pace in H2 2020, one thing is becoming clear – bank clubs are scarcer. Direct lenders have gained ground, particularly on speed of execution, with many PE firms pre-empting deals and tapping funds for financing to get ahead of competitors in an overheated market. While funds have been blazing ahead to deploy, banks have proceeded with caution, picking their battles carefully and favouring the more lucrative underwriting model.

Another sticking point for banks this year has been COVID-adjusted or forward-looking 2021 EBITDA calculations, neither of which have gone down well at banks’ credit committees. Add to that the fact many banks have suffered in the pandemic, making them more hesitant in the senior club arena. Regional differences are emerging, however, with banks in the DACH region continuing to offer strong competition.

“It seems it’s the case everywhere in Europe that banks are retreating from the mid-market except for Germany, where they’re basically doing unitranches. They’re not on every deal but prove extremely aggressive for the assets they know and like. It’s really annoying for us actually,” said a Germany-based direct lender.

“In some cases, you’re seeing bank clubs having a bit of a comeback, but it’s not on the straightforward deals. Ultimately, we will see a decline in clubs and a shift to unitranche, but on certain deals the senior option is attractive,” said a Netherlands-based banker.

Mushroom growers CNC gets big backing Sun European’s acquisition of CNC Holdings, a Dutch mushroom substrate business, was backed by a circa €75 million unitranche provided by Crescent Capital, according to two sources familiar with the situation.

Though the deal was marketed off around €20 million by sell-side adviser EY, CNC’s 2019 EBITDA was closer to €16 million, with €91 million of revenue. Financiers were considering leverage around or below 4x. Pricing on the debt is around Euribor+ 650 bps, one of the sources added.

CNC Holding comprises five companies that focus on production and transport of substrates for growing mushrooms, with locations across the Netherlands and Poland. The businesses range from CNC Exotic Mushrooms B.V., which provides substrates for edible mushrooms grown on wood or compost, to AMCO B.V., which transports straw-rich horse manure. There were questions throughout the process around the co-operative ownership, but the asset was viewed as strong within the substrates industry.

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Direct lending has demonstrated its resilience

Pent-up demand portends rapid reversal of 2020 misfortunes

European direct lending volumes plunged to €16 billion in 2020, down 56% year on year, according to Debtwire Funds Data. But despite the slowdown, market participants are confident fundraising will pick up in 2021 by virtue of supply and demand.

Oquendo and Sixth Street gave figures a slight boost in Q4. The latter closed its second European direct lending fund, Sixth Street Specialty Lending Europe II, at its €1 billion hard cap, while Spanish direct lender Oquendo closed Oquendo Senior at €172 million, above its €150 million hard cap.

“2020 was the first time European direct lending was tested through market stress … perhaps investors who had outlined deployments were waiting to see what happened and how resilient the asset class was,” says Trevor Castledine, investment consultant at bfinance.

“The good news is that direct lending has proven to be very resilient. If that were a reason why people were holding back, it could be a complete reversal this year with the pent-up demand,” he says. Moreover, investors must deploy throughout the years to maintain vintage diversification among their portfolios.

Another factor that caused figures to dip in 2020 was LPs focusing on their own portfolios in times of volatility, as well as uncertainty over virtual due diligence and willingness to invest virtually.

Peter Martenson, partner and head of global distribution at placement agent Eaton Partners, says LPs are slowly becoming more comfortable with virtual meetings – but the number of touch points the firm took with investors to close a fund commitment increased significantly.

“Pre-COVID, it took about 27 points of contact with investors to close a commitment, whether that was through conference calls, meetings,

emails – either with just us or the manager. During COVID, that increased to 42,” Martenson says.

“The good thing is that the virtual aspect has allowed us to organise these more efficiently, as we used to be able to meet two or three times physically before you close a commitment. At the same time, there is a lot more handholding with investors.”

Public capital markets and their performance continue to drive LPs towards private market investments, with investors facing increased volatility across their equity portfolios and reduced yields in their fixed income allocations. Private credit provides diversification, stable income and higher yields.

Christine Farquhar, managing director and global head of the credit investment group at Cambridge Associates, says she is seeing growing demand for senior direct lending, particularly from European investors.

“European pension schemes are less likely to be derisking than in the UK and want to enhance their projected returns,” she says. “In the UK, there are other factors such as maturing final salary schemes, rebalancing, derisking and cash withdrawals. There has been some demand, but less freedom to move in that direction.”

Castledine says some of the firm’s biggest mandates last year were from insurance firms, largely towards the more conservative end of the senior corporate direct lending funds.

On the supply side, 2021 looks set to be a great vintage for direct lenders, with a plethora of deals and slightly better documentation and deal terms. There will also be many opportunities for refinancings from the record 2017 year.

Performance continues to be the biggest driver for new fund selection, investors have

Robin ArmitageResearcher

Creditflux

Michelle D’SouzaReporter

Creditflux

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raising

highlighted. In 2020, investors flocked to quality, established managers, considering them safer bets.

COVID-19 has placed a magnifying glass on direct lenders. LPs acknowledge that the pandemic has underlined differences between managers in terms of deal origination, documentation and risk management capabilities – though the full impact on this won’t be fully visible for another two or three years.

Private debt fundraising seems well placed for 2021. Figures will be greatly enhanced by larger managers such as Ares Management, which raised €9 billion for its latest European direct lending fund (as of 31 December), and Hayfin Capital Management, which exceeded and ultimately scrapped its €5.5 billion hard cap. Both have yet to hold a final close.

Despite optimism surrounding the distribution of COVID-19 vaccines, there remains cause for concern in the light of emerging coronavirus variants and recurrent lockdowns. Fundraising looks certain to increase – the question is when?

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GSO European Senior Debt Fund II Blackstone 4,400

Permira Credit Solutions Permira 3,480

Crescent European Specialty Lending Fund II

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AlbaCore Partners II AlbaCore 1,500

European Asset Value Fund II HPS 1,380

European direct lending highest 2020 commitments

LP Fund Manager Commitment (m)

Virginia Retirement System Ares Capital Europe Fund V Ares $300

Harmonie Mutuelle Fond Harmonie Mutuelle Emplois France Eiffel €200

Pennsylvania Public School Employees' Retirement System

Sixth Street Specialty Lending Europe II Sixth Street $125

Oregon Investment Council Sixth Street Specialty Lending Europe II Sixth Street $125

Maine Public Employees Retirement System

Ares Capital Europe Fund V Ares €100

New Mexico State Investment Council ICG Senior Debt Partners IV ICG $100

On the supply side, 2021 looks set to be a great vintage for direct lenders, with a plethora of deals and slightly better documentation and deal terms.

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EDLP_PrivateDebtAd_2020_v6_DS.indd 1EDLP_PrivateDebtAd_2020_v6_DS.indd 1 04/03/2020 13:1804/03/2020 13:18EDLP_Q4 2020_Book_V1_AT.indb 22EDLP_Q4 2020_Book_V1_AT.indb 22 01/12/2020 15:15:1601/12/2020 15:15:16

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ireFeature2020 in review:

When will direct lending’s real test begin?The industry spent 2020 in a holding pattern, with direct lenders waiting for the worst of the COVID-19 crisis to dissipate and reveal what parts of their businesses demanded the most attention

There was a certain amount of optimism at the start of 2020. Despite some visible cracks in second and third funds due to underperforming deals, market conditions were good and direct lenders were considering how to build on the success of the 2010s. Still, the industry forecast that a downturn was looming and Europe’s direct lending sector would see its first great test. When the COVID-19 pandemic struck, it seemed the test was about to begin: M&A tanked, fundraising suffered, pricing rocked and the market bifurcated as lenders patched up portfolios and took stock of restrictions ahead.

However, looking back at the last 10 months, it seems the industry has not been so

much tested as put in a holding pattern, as government assistance programmes provided a buffer and lenders ran for cover in COVID-resilient industries. By the end of the year, leverage, margins and terms returned to pre-COVID levels.

“We invest with a long-term perspective and with good fundamentals, and I think we would have had a different approach to the sponsors if this was a real macro-economic crisis,” said a direct lender.

Still, the year was not business as usual, with plenty of quirks and lessons learned, as well as one major question that has been

Karis HustadReporter

Debtwire

Carl-Johan Kullving Nordics Reporter

Debtwire

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left unanswered so far: When will direct lending’s real test commence?

Buffer factorsThe financial support and furlough packages introduced by European governments lead some people to argue that direct lending has yet to face a substantial challenge. PE houses were also able to direct cash towards portfolio companies in need of liquidity, with most lenders and sponsors able to work together to address potential covenant breaches and lack of cash flow.

Furthermore, the impact was unequal across industries: virus restrictions slammed certain

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sectors especially hard, such as travel, leisure retail and restaurants. While some of these have always been risky for leveraged finance, some seemingly certain bets — such as airplane- and airport-related services — did not pay off.

“COVID has been so specific in which industries it hit hard, so it’s difficult to see which direct lenders have been doing a bad job,” said a second direct lender.

Back to core businessWhile M&A activity dwindled as the pandemic began to surge in Europe, the market saw a recovery in H2. With most banks closed to activity, direct lenders had more optimism and could have a more opportunistic approach to the new deals that were testing the market. “The quality deals were very contested,” said a mid-market fund manager.

Pre-existing relationships between owners and lenders became even more important, as travel bans stamped out physical meetings. Some sell-side advisers also pushed for more transparency in the market by securing staple financing options in sale processes to make sure all PE bidders were able to bid, with lending alternatives secured at an early stage.

EBITDAC attack While testing the boundaries of adjustments is not new in M&A, 2020’s unique conditions saw another letter affixed to the EBITDA acronym: C. EBITDAC — ‘EBITDA before COVID’ — has started to be used as a measurement. In some cases, sponsors are using the pandemic as an exceptional item, adding back items related to business interruption insurance, restructuring costs and lost revenue.

“People thought this was a joke at first, but no,” said an M&A adviser. “They look at monthly performance during the summer and then compare with performance during the second lockdown to argue what is the real performance of the business without COVID. I know, it’s extreme, but if a company is solid and there is good management, they go ahead.”

Structures that changedThe outbreak of the pandemic also introduced new ways to look at financial structures to create headroom and save space in case further liquidity needs arose. Lenders stood back from FOLOs, only fancied when margins and fees were higher and there was a possibility for a future refinancing. Club deals were also less common, as PE houses sped up auctions by pre-empting the hottest companies.

LP’s hunger for deployment continuesDespite the market uncertainty, LPs were willing to support the asset class. 2020 recorded a

fundraising total of €16 billion across 15 funds that had final close. Still, it was a huge drop from 2019, when 23 funds had final close with a total amount of €37 billion, according to Debtwire Funds Data.

“The fundraising has been going very well. The LPs are still trusting us and the business model – that feels good. But I know some competitors that are struggling,” said the second direct lender.

The year in numbersDirect lending loan volumes in the mid-market space dropped to €4.1 billion in 2020, far below the €6.5 billion in 2019, according to Debtwire Par. Nonetheless, margins have managed to recover to their pre-COVID levels. Average margins for unitranches averaged 700 bps in Q1 and Q2, dropping to 625 bps in Q3 before rebounding to 675 bps in Q4.

Average leverage levels for unitranches started on an all-time high in Q1 at 6.6x but plunged to 4.1x in Q2. The market saw some recovery in Q3 as levels climbed to 5.5x, ending in the last three months of the year with an average of around 5.3x.

Start of the roaring 20s?In some ways, it seems the industry has weathered the storm and optimism might return for 2021, particularly with vaccines being rolled out across Europe and Brexit finally done. Government spending on COVID-19 support has created a window for M&A to push forward ahead of March, and companies are preparing for a wave of economic activity as restrictions lift.

However, in the light of emerging coronavirus variants, renewed lockdowns and unguaranteed government support, lenders might need to prepare themselves for another spring of covenant renegotiations, equity injections and restructurings. The pandemic is far from over – and the real test is perhaps yet to come.

After a quiet start to Q3, the auction pipeline has picked up significantly, with vendors keen to hit the market with assets that were ready for sale pre-lockdown.

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Direct lending’s new year euphoria

Robin ArmitageResearcher

Creditflux

Replies to our annual direct lending survey reveal that, after the trials and tribulations of 2020, direct lenders are much more bright-eyed and optimistic in their outlook for the year to come

How much do you expect European-focused direct lending funds to raise in 2021?94% of survey respondents expect European-focused direct lending funds to raise more than €20 billion in 2021. In our 2019 survey, only 63% of respondents anticipated this, yet fundraising blew away expectations with record-breaking sums (€37 billion). 84% of respondents said the same in the 2020 survey, though funds ultimately raised just €16 billion in a tough year.

Do you anticipate fundraising to be affected by coronavirus in 2021?With recent vaccine breakthroughs, direct lenders are sanguine – only 9% expect coronavirus to have a significant negative impact on fundraising in 2021.

How do you think this is likely to change in 2021?Survey respondents expect this to improve, as 69% believe fund deployment will build on 2020 figures.

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How much capital did your fund deploy across 2020?Given the challenging conditions, 55% of managers deployed less than €300 million in 2020. According to our 2020 survey, only 25% deployed less than €300 million in 2019.

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Which region do you predict will offer the greatest opportunity for growth in 2021?Direct lenders look favourably on DACH, with almost one-third (29%) identifying the region as offering the greatest opportunity for growth in 2021. UK/Ireland has fallen a few spots (to 16%) post-Brexit, after the region was projected in last year’s survey to lead the way in 2020 (29%).

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How much leverage at fund level did you see direct lenders using in 2020?Replies were split this year: 27% of respondents saw 0x leverage at fund level, while another 27% saw 0.5-1x leverage in 2020.

What was the leverage on your most highly levered deal in 2020?More than one-third of respondents report that the leverage of their most highly levered deal was 6-7x, continuing the trend from last year’s survey where 25% of respondents agreed. That said, 31% of responses saw 4-5x leverage in 2020.

How do you think this is likely to change in 2021?Most respondents (68%) expect leverage to remain unchanged from last year. This was also the case in 2020’s survey; however, few could have predicted such drastic changes in the market.

How do you think this is likely to change in 2021?Following the 2020 survey, most respondents (64%) believe direct lenders will use the same amount of leverage in the year to come.

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What has been the average level of opening covenant headroom for your deals during 2020?Respondents were split on opening covenant headroom for deals in 2020: 39% saw 20-30% in their deals, while 36% saw a higher average level of 30-40%. This is a slight dip on last year’s survey, when 50% said 30-40% was their average level of opening covenant headroom.

Has this changed in the last 12 months?Most survey respondents (69%) report no change to the average level of opening covenant headroom for their deals in the last year.

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What was the average margin on the unitranche facilities you issued or advised on in 2020?Nearly half of respondents (44%) had an average margin of 6.5-7.5% on unitranche facilities they issued or advised upon in 2020.

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What proportion of your unitranche facilities issued during 2020 had a first loss/second loss structure?A strong majority of respondents (81%) say that less than 20% of their 2020 unitranche facilities had a first loss/second loss structure. This is a major change from last year, when 46% of respondents said fewer than 40% of their unitranche facilities had a first loss/second loss structure.

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How do you think this is likely to change in 2021?Heading into the new year, most respondents (64%) do not expect to see a change in the proportion of unitranche facilities with a first loss/second loss structure.

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What percentage of companies in your portfolio have waived covenants or had a covenant holiday in 2020?Almost all respondents (96%) claim to have had between 0-40% of companies in their portfolio waive covenants or have a covenant holiday in 2020. More than one-third (39%) say 11-20% of companies in their portfolio have waived covenants or had a covenant holiday in 2020.

What percentage of companies in your portfolio defaulted in 2020?More than half (52%) of survey respondents saw less than 2% of companies in their portfolio default in 2020. Almost one-quarter (22%) were lucky enough not to suffer any defaults at all.

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What has been the greatest challenge faced by the direct lending market as a result of coronavirus?For nearly half of respondents (47%), portfolio management was the biggest coronavirus-related roadblock. 22% say the lack of face-to-face interaction was their largest hurdle that could have led to difficulties fundraising, as was the case for 19% of respondents.

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What was the average cash margin on your deals during 2020?Most respondents (61%) say the average cash margin on deals in 2020 fit into the 5-7% bracket, with 7-9% following as the next most popular answer (32%). No respondents saw average cash margins above 9%.

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The conditions are right for a strong 2021 for direct lenders

Direct lender: Natalia Tsitoura, managing director and head of European private debt, Apollo Global Management

In Q4 2020, you could be forgiven for failing to find signs of the pandemic in the direct lending space, with incredible deal flow volumes more than compensating for the H1 plunge. PE sponsors largely dealt with internal portfolio issues and focused on deploying new capital, driving appetite from direct lenders. This seems set to continue in early 2021.

In 2020, lenders favoured defensive sectors such as telecoms, business services and healthcare, while largely avoiding industries impacted heavily by COVID-19, such as retail, travel and leisure. As lenders, the challenges are sourcing the right kind of deal flow and pricing that risk accordingly.

We expect COVID will continue to accelerate trends visible in the US market, including increased ticket size for deals. This is due in part to larger funds being raised, greater education on the benefits of direct lending, banks retreating and syndicated markets pulling back in times of stress. It’s a perfect storm for direct lenders, who are well positioned to fill this void.

The latest European lockdowns will clearly be a challenge for some portfolio companies, but, overall, we think 2021 will be a great lending environment, particularly as M&A activity accelerates.

Should challenges arise, direct lenders can work with borrowers on potential solutions to address their varying liquidity situations and capital structures. For example, late last year, Apollo worked with US media company Gannett to refinance around US$500 million of debt. The deal generated savings for Gannett, extended debt maturities and put the company on a path to refinance the outstanding portion of the loan on favourable terms in 2021. This was possible because of our close connectivity to the company and belief in their long-term strategy. Cases like this illustrate plainly the benefits of private credit and why we think the asset class will continue growing in Europe.

The story of 2021 will be the health of portfolios

Direct lender: Paul Johnson, partner and head of direct lending, Bridgepoint Credit

It comes back to what you’ve been doing for the last two or three years; we have invested around 85% in defensive sectors, such as healthcare or software with recurring monthly revenues, and that resilience has played out well. However, lenders with meaningful funds and on their second or third vintages are not coming into this with an entirely clean portfolio. And with recurring waves of COVID-19 infections and attendant lockdowns, recoveries may take longer than expected.

One positive takeaway is that LPs can really assess the level of risk managers are taking and are able to differentiate the managers. That was not the case a year ago. Managers were showing similar leverage levels and 8-10% returns on their pitchbooks. If you returned 10+% then, you were probably taking on more risk which is now manifesting.

LPs appreciate the more granular, data-led assessments. Companies were often assessed on a subjective traffic-light system, where lenders knew which ones were more exposed to a downturn or economic shutdown. Now, LPs are asking tougher questions: What happened to leverage? Did you miss any interest payments? Have you breached covenants?

They can also see the ‘real’ portfolio health and cut through some of the creative COVID adjustments going on. Lenders are not fooling anyone but themselves using those adjustments.

We remain bullish on new deal flow. Q4 was our busiest-ever quarter in terms of deployment, partly due to a market rebound in terms of volumes, but also due to the enlarged EQT/Bridgepoint team, with more local offices able to address sponsors’ needs. We had our first pipeline call and many of these are in their early stages, but it now certainly feels busier than previous opening quarters.

Direct lending as an asset class should come through this crisis well and increase in relevance for its investors for future funds and PE.

The dust is still to settle

Direct lenders and other experts give their prognosis for 2021 as the industry readies to bounce back from the dour times of last year

Michelle D’SouzaReporter

Creditflux

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Much time still to pass before dust begins to settle

Debt advisory: Patrick Schoennagel, managing director, Houlihan Lokey

By and large, private credit lenders have done well to navigate the challenges of 2020. But new lockdowns could wreak havoc in a lot of portfolios, depending on how long the crisis persists.

Many companies were able to get through last year thanks to government assistance, lenders being flexible and covenant waivers. That said, there is going to be some fatigue with lenders and, ultimately, instances of covenant breaches.

Good companies with reasonable balance sheets will have to have some tough discussions with their creditors depending on how the current lockdowns evolve. Not many companies’ leverage covenants, even when set as loose as they have been, will be able to withstand the pain inflicted by a year-and-a-half-long severe reduction in economic activity.

Companies that only have a financial covenant and not a liquidity problem will have already been placed on the ‘OK’ list. The real focus in the next three to six months will be companies where a recovery was expected to have begun and that upturn is further deferred due to fresh outbreak of COVID infections and subsequent lockdowns.

It will be interesting to see which lenders have the organisational wherewithal to continue deploying capital into new transactions in the face of renewed uncertainty. It’s likely that several private credit providers will be preoccupied with portfolio matters, as these discussions take up a great deal of time. Lenders that have several triage cases in their portfolio but are not big enough to have a separate workout team to address them will likely need to take their foot off the pedal for new deals due to resource constraints.

For all that, 2021 has opened with a robust pipeline. One factor that has spurred UK activity is the upcoming budget, with many shareholders looking to sell quickly before any change in capital gains taxes. However, the dust will only settle in around two years’ time when one can see longer-term fund performance.

Buying time to enable the recovery of good businesses

Leverage provider: Arun Cronin, managing director, Credit Suisse

Some leverage facilities contain valuation haircuts based on financial metrics such as a company’s debt/EBITDA ratio. These haircuts can be quite punitive in an environment where market dislocation, such as that engendered by COVID-19, has caused debt/EBITDA ratios to spike in the short term. The application of these haircuts can cause facility loan-to-value ratios to become elevated, potentially triggering events such as cash flow sweeps and reducing cushions to event-of-default thresholds.

We were able to work with our borrowers to provide borrowing base stability through this period of dislocation by waiving some features that were adversely impacting the borrowing base and to avoid LTVs under our facilities becoming elevated. We took this approach to give companies in the most impacted sectors time to recover – a good business does not automatically become a bad one because of lockdowns. We have found that the underlying companies have generally had adequate liquidity runway to survive the series of lockdowns that have occurred.

There were signs of recovery in H2 2020, but the impact of the second lockdown in Europe will again hurt earnings and increase leverage in certain sectors. However, we will not get March financials until well into Q2 and, hopefully by that stage, COVID-19 vaccines will have been rolled out more widely and companies’ revenue lines will have stabilised.

New deal flow remains strong with a lot of private credit funds continuing to raise a levered and an unlevered sleeve. We remained active throughout 2020, doing our first post-COVID facilities in late Q2.

At the height of the pandemic, spreads blew out from the low-to-mid 200s to the low 300s. They have now tightened to the mid-200s, depending on the manager and strategy. Other risk terms such as eligibility criteria, super senior tolerance and principal cash sweeps have also tightened slightly, but the differences are not especially meaningful.

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The two types of troubled company

Lawyer: Aymen Mahmoud, partner, McDermott Will & Emery

Uncertainty amid global markets favours private debt, much as it did in 2008, where many banks will be increasingly mindful of tighter regulation and lending practices. Direct lenders are best placed to take advantage of this in the case of bank inaction and relative certainty of transactions versus syndicated bank loans, evidenced by their continued involvement in M&A throughout H2 2020. They can also act as strategic partners to their borrowers, using patient capital to take minority equity positions or kickers to align interest, something that banks tend not to do outside of a restructuring. This will no doubt continue into 2021 as COVID-19’s impact endures.

Overall, lenders seem to have managed their portfolios effectively. But it is difficult to see the precise nature of the impact – auditors are taking longer to provide audits, there remains uncertainty around supply chains and extended payment terms may be needed to shore up counterparty liquidity rather than it being indicative of underlying issues. Government intervention, which can mask certain issues, makes it difficult to identify liquidity needs in credit markets.

Still, there remains a strong appetite for the asset class. In the event of a sustained period of impact, there will be some consolidation among asset types or verticals. PE firms, with significant levels of dry powder, will take advantage of any reduction in pricing to bolster existing portfolios. Sponsors have historically been wary of burgeoning prices and the increasingly competitive nature of M&A, so any dip will act as an incentive to transact. Lenders remain very interested in defensive sectors such as technology, healthcare and software. Pet food businesses were also popular last quarter.

Documentation remains focused on deep underlying credit questions such as dividend levels and debt incurrence. Anti-hoarding or liquidity covenants, terms that people were talking about when the pandemic first struck, are less prevalent today.

There are really only two categories when it comes to troubled companies: the ones that need to restructure and the ones that need some liquidity to get them through the next three to six months. The plethora of special situation funds that can provide some of that more opportunistic capital, alongside the direct lending dry powder out there, means we do not have that liquidity drought we had in 2008.

For companies restructuring in the UK, new insolvency legislation has made things more efficient about who is going to get what, and it has made it a bit more difficult for distressed hold-out creditors to extract value where they have no economic interest. Whether in unitranche or super senior structures, it’s a step that enables enhanced credit analysis.

Flow was low, but dialogue is on the up and up

Private debt secondaries: Olga Kosters, managing director and head of private debt secondaries, Tikehau Capital

Following the volatility in public markets, deal flow alleviated in H1 2020, but we saw a marked uptick in enquiries from people who had previously not engaged in the space. We expect this trend to continue in 2021.

Private debt secondaries volume for 2020 was around US$5 billion-US$10 billion, with direct lending responsible for a large part of that flow. However, given Europe has historically been behind the US, there is a smaller universe of primary funds and that is also translated into secondary volumes. That being said, we did see some interesting deals in the European direct lending space last year, both older vintage LP stakes and GP-led deals.

LPs started looking at their existing portfolios differently – instead of buying and holding funds until the end of funds’ lives, some LPs started taking a proactive view and the secondaries market benefited. Deal flow was also driven by volatility in public markets. Several LPs took a ‘risk-off’ stance, adopting a more cautious approach to future allocations, which also trickled into private debt secondaries. Private market volatility brought some very interesting valuations from the buyers’ points of view.

GPs took a more creative and active approach in 2020 and are looking at the secondary market as a tool set – either solving for the duration of the older vehicles and moving out some assets into new vehicles, diversifying their investor base or other considerations they are trying to find a solution for. Each deal is different, but there has certainly been more dialogue in the space.

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About Creditflux and Debtwire

Debtwire, an Acuris company, is the leading provider of expert news, data and analysis on global leveraged credit. Our end-to-end coverage goes behind the scenes from primary issuance to the first sign of stress through restructuring and beyond. With global breadth and local depth, Debtwire’s award-winning editorial, research and legal analyst teams produce original content that helps subscribers make more informed decisions. Subscribers trust Debtwire – the pioneer in the market – for comprehensive coverage across geographies, companies and asset classes.

Visit debtwire.com for further information.

Creditflux

Creditflux, an Acuris company, has been the leading supplier of global news and analysis on structured credit funds since its launch in 2001. We publish a monthly newsletter, online daily news and a comprehensive fund database of CLOs and other credit funds. Creditflux provides unrivalled news and analysis for investors, dealers and service providers who need to know what is going on in these fluctuating markets and is often first with the key information these firms need to know about these asset classes.

Visit creditflux.com for further information.

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