- “It’s Not Just About Rates,” as Lenders Start to Retrench – As rates seem to continue their upward trajectory, borrowers rush to try to lock in the lowest rate possible. However, given the flux in the marketplace, institutional and more traditional lenders, in particular, are beginning to pull back on what deals they will approve. Deals and borrowers which may have been “credit-worthy” a few months ago are now facing increased scrutiny, or rejection. Regardless of whether the “retrenchment” is fleeting or sustained, the dislocation will most certainly continue to open opportunities for private credit and alternative lenders/sponsors to fill the void.
- Lender Underwriting Anticipates a Recession in 12-18 Months – Despite the political and anecdotal economic predictions of whether another recession looms, a significant number of lenders are already underwriting with the expectation of a recession occurring in approximately 12-18 months. What this means for deals now, is that borrowers will find it increasingly difficult to obtain financing approval if lenders perceive that their operations or finances will suffer substantially in a tightening market. The risk of recession is also prompting an increased use of delayed draw facilities, as borrowers seek to shore up additional liquidity in anticipation of potential needs.
- Direct Lending is Starting to Move Upstream Into the Syndicated Space – Larger loans, particularly for higher-credit borrowers, are increasingly remaining in the direct lending space rather than turning to a syndicate. For borrowers, this trend may signal a greater willingness from their existing lenders to take on more credit risk, or perhaps this may signal a desired move away from intercreditor intricacies. As markets retrench a bit, however, a move towards more syndication and shared market risk is very likely to increase.
- An Expanse of Undeployed Capital in the Market Could be a Boon for Borrowers – Since 2008, there has been an increasing build-up of capital sitting on the sidelines waiting for pricing to drop, but the next market recession may not see the same “loan to own” player resurgence that was prevalent in post-2008. Instead a new breed of value investors (more likely to work with borrowers in order to deploy capital for the upside) may become more prevalent, and the influx of cash on the sidelines may likely provide greater choice to borrowers.
- Private Equity is Increasingly Becoming the Borrower – There is continued strong interest by sponsors in the use of subscription lines and net asset value (or NAV) loans, as well as warehousing, with proceeds from these lines increasingly being considered to fund distributions and even capital calls for sponsors. With further market disruption, the use of these lines is likely to continue for fund-level borrowers, although proceeds in a disruptive market may be used more for a traditional “shore up” of poor performers in a sponsor’s portfolio. Sponsors and sponsored borrowers, as well as lenders, can expect further creative structuring in these types of lines.
- The Next Recession Won’t Be Like the “Great Financial Crisis” – While predictions abound as to whether another recession is inevitable, the next recession will most certainly not be like the “Great Financial Crisis.” The build-up of cash since 2008, regulatory changes and mandated diversification for lenders and a strong zest for “value investing” deals is expected to soften the blow. At the same time, however, covenant lite, covenant-free and covenant-loose deals have “ruled the roost” as of late, along with continued pressures on EBITDA adjustments. This weakening or diminishing of covenants will have the tendency to strip the much needed brakes on otherwise “runaway” train situations, a circumstance eerily reminiscent of the GFC.
For our borrower clients, these trends overall suggest that higher borrowing costs, combined with an increased scrutiny on operations and business continuity, will be the near-term norm. At the same time, the influx of options can present more creative ways of structuring to meet your business needs. For our lender clients and sponsors, the shift suggests further points of opportunity in the coming years, whether from a value play perspective or simply from the ability to reach investments otherwise unobtainable in a more competitive norm. At JMBM, we are continuing to see these trends play out, with the hindsight of experience in having helped our clients navigate tumultuous markets many times before, and we continue to assist our clients with the creative and fundamental market structuring that is and will be inevitably required.
Marianne Martin, Partner, Corporate Department
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This update is provided to our clients, business associates and friends for informational purposes only. Legal advice should be based on your specific situation and provided by a qualified attorney.