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Six reasons behind direct lending’s rise to the top

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Six reasons behind direct lending’s rise to the top

The private debt market has surged in popularity in recent years as investors in search of higher yields pursue 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 the new kids on the block in the capital markets, but they are certainly one of the biggest in the playground after record-breaking fundraising activity in 2021.

Direct lending loans provide non-bank creditors, generally asset managers, with the opportunity to make direct investments into middle market companies – those companies reporting between $50 million and $1 billion in annual revenue. The loans are a critical source of capital for corporates as banks have continued to retrench from traditional lending channels since the Global Financial Crisis. 

Funds focussed on direct lending now represent a significant share of the private credit market, accounting for approximately 58% of capital raised globally (a record $112bn) by credit funds during 2021. 

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

  • Direct lending loans offer asset managers higher returns than other credit investments such as BSL loans and bonds, but with less risk. 
  • They offer greater protection from rising interest rates as they have a shorter duration than fixed rate debt.
  • They don’t decline in value as interest rates increase. This is because they have floating rate coupons that rise in line with the underlying reference rate associated with the transaction.
  • They carry seniority on the lien of assets. Both senior and subordinated loans are at the top of the waterfall ahead of bonds on pay outs for a default. 
  • Direct lending loans offer greater protections to lenders because they are secured by company assets. Because they rank higher in priority to bonds, the covenants papered in loan agreements provide for stronger restrictions to the company incurring additional debt, for example, and require companies to maintain specific leverage and interest coverage ratios that are regularly monitored. 
  • They offer lower potential losses in default and have significantly higher recovery rates to BSL and bonds.   

Private debt success set to continue

The future looks bright for private debt funds. They have even been able to escape the pandemic's volatility largely unscathed. This is because private credit assets are not publicly traded and being held in closed-ended structures they are less exposed to the market’s capricious nature. They now look set to continue their success throughout 2022 and funds are focusing resources on securing new deal flow. 

As White & Case LLP highlighted in a recent article, according to Nuveen “the potential pipeline of transaction opportunities for private debt managers looks promising. The ratio of dry powder held by PE firms (the primary users of private debt capital) versus private debt funds sits at 5:1. As private market M&A deals are typically structured with debt of between 50 percent and 75 percent of total pro forma capitalization, the ratio of debt dry powder versus PE dry powder would have to shift to between 1:1 and 1:4 before there was any risk of private debt market saturation. All of which means post-pandemic supply-demand dynamics still favour private debt managers." 

Private debt managers evidently have the capital in their arsenal to move in on new financings, execute them quickly and deliver superior returns.

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

Engaging specialist loan agents can increase deal flow and reduce risk

Specialist independent loan 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, expedite KYC proceedings, and receive bespoke, impartial solutions for their transactions by engaging with an independent agent. 

Borrowers can also benefit from having a professional and independent loan agent managing their loans as it provides an efficient and trusted solution to transaction conflict and administrative issues. 

Give your transaction the best chance of success

At Ocorian, we provide full loan agency services including serving as administrative agent, facility agent, or security agent in the world’s key financial hubs, including the US, the UK and Northern Europe.

Our global loan agency teams, including our subsidiary Nordic Trustee – the leading loan agency provider in the Nordics - are currently acting on more than 100 private debt financings covering all types of structures. 

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

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

Contact us below to discuss how you can leverage our team’s loan agency services and presence in 20 global locations.

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