Fri 08/05/2022 11:50 AM
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Middle Market industry coverage from Reorg's EMEA Middle Market team. Reorg subscribers can access all editions of this industry update HERE.

Private debt, which earlier this year was briefly expected to provide relief to the syndicated market and even challenge it, is gearing toward a risk repricing as direct lenders assess their return parameters. They have already been lowering leverage on recent financing by up to a full turn and turning down risk.

Since the start of the more recent geopolitical and macro uncertainty, direct lenders have been waiting for a new benchmark to emerge for pricing. The ECB’s 50 bps interest rate hike on July 21, was double what was expected and investors are voicing some concern. Margins have already increased by between 25 bps and 100 bps for loans in the middle market in the last few months and this is expected to increase further and faster for bank debt and private credit.

Some investors said they are expecting a rise in hybrid financing including a high proportion of equity warrants of 15% or above. Combinations of senior, junior and preference shares are being considered in order to garner higher returns.

A secured €700 million unitranche from HPS Partners alongside other direct lenders to finance TPG Global’s acquisition of Italian generic drugmaker DOC Generici was part of a 6x-leveraged package. This is one turn below the 7x leverage targeted in February and March around the time of Russia’s invasion of Ukraine and before the global economic outlook worsened with central banks increasing rates to stave off inflation.

Astorg decided to acquire Belgian provider of insulation products IPCOM in a fully equity underwritten deal in July after lenders reduced the leverage to 4.25x from 5.5x. Incumbent lenders of the company included Barings and a pool of banks. The sponsor will seek a new debt financing package after the summer.

Lenders also cut the leverage they are willing to offer to debt-finance the sale of U.K.-based manufacturer Technical Fire Safety Group to about 4x leverage from between 4.5x and 5x earlier on in the process.

Direct lenders’ capacity has declined due to heavy deployment at the start of year and concerns over a more challenging macro background, one source said. Although pricing on debt raised via direct lending is higher, it has not widened to the same extent as pricing in the public market in the first half of this year.

Private debt supported mega deals such as CD&R’s purchase of Morrisons at an enterprise value of £9.8 billion and the £3.2 billion debt refinancing for U.K.-based business management software provider Access Group.

As a counter to that, Optigroup and Gaming1 deals, which were initially launched for syndication in the leveraged loan markets, were temporarily put on hold when market conditions worsened, with expectations that they would have to raise financing via direct lenders.This wasn’t the case and forced the arrangers of those deals to do run pre-marketing and sell the deals with high margin and heavy OIDs.

Banks are keen to get underwritten deals off their books, but direct lenders usually expect wider OIDs than the syndicated market because they can typically offer higher leverage to borrowers and because they usually take larger debt tickets, sources said. When a deal has struggled syndication, direct lenders are encouraged to demand even higher pricing, a buysider said. Raising debt this way will result in an even greater loss for banks, who recently have forfeited all or most of their fees on many deals because of the OIDs demanded by investors in the syndicated market.

Optigroup’s debt, to fund the acquisitions of OptiGroup and Dutch B2B distribution business Hygos by FSN Capital Partners, is thought to have been in pre-marketing just as Russia started its invasion of Ukraine. The deal was then launched to the broader syndicated markets in May under a structure comprising a €515 million term loan B and a €50 million delayed draw term loan B. Pricing for the term loan B in May started at Euribor+525 bps with an OID in the range of 94 and 95, but when market conditions deteriorated, the OID on the issuance is thought to have widened as far as 91.

After considering different options, including direct lending, more favorable conditions enabled the deal to come back to the loan market in July with a different structure comprising a €365 million seven-year first lien term loan B and a €200 million second lien facility, which was privately placed. The first lien TLB priced at an OID of 90 with a E+525 bps margin while the second lien facility will pay E+800 bps.

“Direct lenders are asking for guarantees,” one private debt advisor told Reorg. At the moment, there are no changes in documentation and no additional covenants are being included, but funds want to make sure they will win the deal, otherwise they are not spending any time on live transactions, they are being “very selective,” the source added.

In the U.K. this summer direct lenders are prioritizing opportunities in perceived resilient sectors, with the testing, inspection, certification and compliance, or TICC, market being a popular choice. Two U.K. companies, Phenna Group and Construction Testing Solutions, are expected to be up for sale later this year and are already attracting attention, while U.K. certification provider Amtivo and U.K. healthcare provider Vita Health Group are currently in auction and Bridgepoint is expected to sign its acquisition of MiQ, which is expected to be supported by private credit.

According to Deloitte’s Alternative Lender Deal Tracker for the first quarter of 2022, activity for companies with EV of €50 million to up to €500 million has been busy so far this year and this trend is expected to continue in the second half of the year.

– Jaishree Kalia, Beatrice Mavroleon & Lucía Camblor
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