Are Direct Lenders making Levfin Irrelevant?

I'm an incoming analyst at a MM IB levfin group, and when I was an SA, we ended up losing a deal to direct lenders. At the time, the VPs in my group seemed to indicate that this was a common occurrence. Recently, I've been reading up to prepare for the job and stumbled onto a primer discussing direct lending. After reading it, I was wondering why anyone still bothers with a traditional syndicated process. Aren't direct lenders both faster and cheaper?



Also, in terms of my broader career arc, will direct lending eventually make levfin irrelevant? Any ways to mitigate this? Should I try to exit to a direct lender ASAP, move up to BB levfin (more use of HY bonds in bigger deals means less of a role for direct lenders)? Thoughts would be appreciated, thanks. 

 

In my opinion there will always be a spot for the banks.

Whether it is "lowest cost of capital" or just doing the agency shit that no one else will do (some lenders are very uncomfortable with rental agents running a syndication), banks will provide some sort of value.

The deals may get far less exciting, almost hairless and more process / regulatory oriented than actual underwriting and diligence, but they'll always exist.

 

Couple of questions if you don't mind. Why would anyone care about cost of debt when a unitranche is cheaper because you only have to provide one set of loan docs? What agency shit are you referring to and what do you mean by "rental agent"? By hairless do you mean fees are going down? And what do you mean by regulatory and process-oriented versus underwriting and due diligence? Thanks for your help, trying to learn here.

 
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Direct lenders are becoming more prominent given the sheer amount of money that's been injected into the private credit asset class, but the broadly syndicated market will always remain relevant, and is definitely not going away. Not gonna list every single point as it'll get too long but I would say the 2 most important points are:

  • Lower Rates - the syndicated loan market generally offers lower rates. Direct Lenders (typically structured as BDCs) have a return on capital hurdle that well exceeds (even with leverage) the S+325-350 range that the broadly syndicated loan market typically offers for single-B level names (although right now it's more like S+425-450 due to the Ukraine/Russia crisis). Simply put, if you want a sizable loan at the lowest rate, the syndicated loan market is still the way to go. This is why these days you typically see banks underwrite the 1L TL and then the sponsor pulls in direct lenders for the 2L TL - the business model of most BDCs simply just does not work at the pricing levels that the syndicated loan market offers for 1L TLs. 
  • RCF hold - if you want a decently sized revolving credit facility for liquidity purposes you need banks. Direct lenders tend not to lend for purposes of RCFs (although they occasionally do so but in very small quantities). This is because their business model differs from that of banks - direct lenders are in the business of lending and holding, whereas investment banks are in the business of underwriting and syndicating the loan while skimming off an underwriting fee in the process. As a result, if sponsors go the direct lender route, they typically need to find an external commercial bank to lend for their revolving facility needs, but finding one & getting the size they need is not guaranteed and definitely not as easy as that in a syndicated deal where it's almost a given that underwriting banks will agree to lend for relationship purposes (given they are getting paid UW fees for arranging the loans).
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I think there are already posted some insightful comments above, but a slight nuance added to the discussion is that I have personally seen Direct Lenders primarily play in the mid-market (EBITDA smaller than EUR 30m). They are 100% reshaping the market in this segment, and are slowly involved in more than half of all transactions (I base this on an internal market research). If I wanted to become a traditional LevFin banker in the mid-market, I would rethink that ambition and see if a direct lender isn't the better option. However, in the large cap market, direct lending does not play a large role yet and banks have by far still the upper hand.

Last to thing to consider, is that many banks also have an internal direct lending arm (or are working on setting one up). If you are in the traditional LevFin team at that specific bank, you could start some coffee-chats and explore whether an internal lateral is of any interest to you. In my opinion though, when people on here talk about LevFin it's pretty much about large cap with institutional, syndicated, TLB's and secured/unsecured notes. That's a completely different experience compared to working on a mid-market transaction (from both a bank/direct lending perspective) where deal size, facility sizes, and structuring (less aggressive docs) is completely different.

 

Simply put, no, in my opinion. At the end of the day DLs are more flexible and have higher risk profiles but at a much higher cost of capital. I've seen especially in PE, if a DL financed company has a chance to pivot to a cheaper syndicate stack, the sponsor will pursue that because why not

 

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