The story of the rise in direct lending as traditional banks retrench is a familiar one for many investors. In another example of the market adapting to new trends, it is now beginning to take market share from the syndicated loan market.
In recent years, geopolitical and macroeconomic turbulence, fuelled by the war in Ukraine, inflation, rising interest rates and oil shocks, has deterred traditional investment banks from underwriting loans in the syndicated loan market. Given the longer lead time from underwrite to market sale, there can be significant market movements during that period. During the first half of 2022, banks were selling down underwritten loans at levels lower than their initial underwrite.
For private equity sponsors, getting an underwrite from a bank has therefore become more difficult, but the demand to do deals remains. And, just like it has since the 2008 global financial crash, the direct lending market has looked to plug the gap, this time with multiple lenders working together on “club deals”.
What is a club deal?
A club deal involves multiple lenders collectively funding a transaction, a departure from the traditional model where a single lender assumes the entire credit risk. This collaborative approach has gained traction as businesses seek larger financing packages, which a single lender is unlikely to provide entirely by themselves. Club deals provide a strategic solution, allowing lenders to pool resources and offer larger transactions at a time when the syndicated market is disrupted.
While direct lenders once focused on individual deals of around €50m to €200m, they are now "clubbing" together to tackle the scale of loans traditionally associated with the syndicated market. Notably, in Q1 2023, direct lenders financed 89% of European leveraged buyouts, compared to 63% just two years ago.1
Why the surge in club deals?
The same factors that fuelled the growth of the direct lending market are driving the popularity of club deals. Sponsors need deal certainty and agility, advantages the direct lending space has historically held over traditional banks. Club deals offer these benefits, but at a scale traditionally associated with the syndicated market.
Implications for investors
In a climate where credit markets are already attractive, club deals offer an additional funnel of transactions for credit managers. The collaborative nature of these deals allows lenders to tailor financing solutions to meet the unique needs of borrowers. This broadens the spectrum of investment opportunities for investors, contributing to a more resilient and adaptive investment portfolio.
Is clubbing the future?
The evolving nature of club deals in private credit indicates a credit ecosystem that is not only responsive to market demands but also committed to finding innovative solutions for the benefit of both lenders and borrowers alike.
Direct lending has carved a niche in the middle between the traditional single lender offer and the syndicated loan market and we expect that even as the syndicated loans market begins to normalise – club deals are here to stay.
References
1 PitchBook | LCD, Data referencing share of European LBOs financed via the broadly syndicated loan market vs. Direct Lending by deal count; Q1 2023 and Q1 2021 figures.
First published in The Alternative Investor October 2023 edition.
