What is the difference between 'Direct Lending' and bank/commercial lending?

john123067's picture
john123067 - Certified Professional
Rank: Orangutan | banana points 265

I've seen the two talked about separately on this site.. Can somebody explain to me the difference? In my group, while we do structure asset-based facilities (revolvers, term loans) to MM companies on a club (us and one other/a few banks involved) and syndicated basis, we also have loans where we are the sole lender to the company (is this not considered 'direct' lending?).

From what I've read so far, it seems that the 'senior secured' / top of the capital structure aspect is shared between direct lending & comm. banking as well, in the sense that direct lenders structure/offer senior secured debt, 1st/2nd lien debt, unitranches, etc. If I'm off-base, someone please inform me.

Basically, looking to learn similarities/differences.

Investment Banking Interview Course

  • 7,548 questions across 469 investment banks. Crowdsourced from over 500,000 members.
  • Technical, behavioral, networking, case videos, templates. All included.
  • Most comprehensive IB interview course in the world.

Comments (12)

May 24, 2018

Bump!

May 24, 2018

Similar premise, direct lending firms are simply non-bank creditors, direct competitors to bank debt, it's all semantics. The direct lending term just means there's no intermediary aka a bank in financing.

Most Helpful
May 24, 2018

The primary difference is regulatory, driven by the different sources of capital. Banks hold deposits, so risk-taking is restricted in a number of ways in order to protect depositors. Direct lenders are raising funds from investors who want the lender to put that capital at risk in exchange for returns. Regulators take a much more hands off approach; they're not nearly as concerned with a fund blowing up as they are with a bank going under.

Banks still dominate the investment grade large corporate syndicated loan space because i) they're low-risk borrowers, so capital requirements aren't as onerous, ii) banks have balance sheets large enough to support the biggest borrowers, and iii) there's a lot of cross-sell opportunities with large corporations, so it's a worthwhile use of capital for big banks. As the borrower size goes down into the middle market and lower-middle market, banks have less cross sell to pursue and higher capital requirements for riskier borrowers. Direct lenders have taken share in this space because they can be as risky as they like, so long as they provide investor returns.

May 25, 2018

Thanks for the detailed response, HC!

May 24, 2018

HighlyClevered's response is bang on, but 3 points I think they didn't cover are:

  1. Direct Lenders fit the gap nicely in lower MM Lev Fin where the financing required is too large for a traditional bilateral loan from a bank, and too small to justify underwriting & syndicating. You can either put together a club of banks who might want to each take a 30m ticket in a 150m TLB, or you can deal directly with a DL who is happy to do a 150m facility with plenty of room for follow-on capital via a capex facility / accordion
  2. In highly competitive processes, dealing with 1 DL rather than a club of banks reduces the risk of matter chatter, particularly if the banks are running multiple trees. DLs will often be more selective on who they work with given lower capacity to resource deals
  3. DLs are less risk-averse and can pursue higher leverage structures i.e. stretch-senior or unitranche facilities.

The above is based on my experience in London, BDCs in the US may operate differently.

    • 4
Learn More

7,548 questions across 469 investment banks. The WSO Investment Banking Interview Prep Course has everything you'll ever need to start your career on Wall Street. Technical, Behavioral and Networking Courses + 2 Bonus Modules. Learn more.

May 25, 2018

Thanks for your response, Mid. Couple questions:

  1. "Capex facility" - is this basically referring to a term loan that is to be used specifically for capex?
  2. What is usually the ballpark minimum ticket size that would be required by a syndication of banks before its just not worth their time/effort? (Is it the $150MM mark you referred to above?)
  3. "Banks are running multiple trees" - what are multiple trees?
  4. Are "stretch-senior" loans simply senior unsecured/secured loans that are more levered than what a bank would typically lever for senior unsecured/secured loans?
May 26, 2018
  1. It's not a term loan, it's a committed facility which normally isn't drawn down upon at signing of the facility agreement, but is available for drawdown for a certain period, with a specific set of drawdown criteria. I.e. it may be a 6 year term, with a 3.5 year drawdown availability period.
  2. I'm not familiar with the American market, but in Europe it would likely be PS/EU150m. It's not that it's not worth the effort, it just doesn't make sense for the issuer. Banks will make the economics work, but the economics of a syndication will typically be more expensive than a bilateral facility from DL on a like-for-like basis. If the issuer doesn't want to go with a DL, arranging a 4-5 club of lenders will normally be cheaper.
  3. Tree = deal team. During an auction, banks / DLs (assuming they have capacity to resource) will run multiple deal teams so that they can work with multiple bidders. These teams will operate independently of each other, and are not to discuss their bidders financing package with other trees so that other bidders don't gain an advantage.
  4. Stretch-senior are just higher leverage term loans. On a hypothetical company which would be levered to 4.0x under a typical TLB, a DL might offer a stretch-senior TLB to 4.5x, or a unitranche option to 5.0x.
    • 2
May 26, 2018

How come direct lending (especially at some small credit funds) is such a lucrative career

How come some hired armies of former bankers when you can start such fund by hiring some relationship managers covering SME and credit officers at a bank

May 26, 2018

I'd be interested to hear an answer to this too. Also, what is typical junior analyst all-in comp (and structure; i.e salary vs. bonus) for someone working at a direct lending fund / private credit fund? (assuming those are the same thing)

May 27, 2018

It's easy to start a fund, it's not easy to successfully raise capital for that fund though. Why would you invest in a fund which is staffed by SME focused credit corporate bankers or the equivalent, when you can invest in a fund which is staffed by former BB / balance sheet bank Lev Fin bankers and who have a network across top PE funds to help deploy that capital.

Compared to other investment strategies, DL funds are not that lucrative. Fees are less, and often only earned on deployed capital rather than raised capital.

    • 1
May 27, 2018

So are you saying that the advantage SME focused credit commercial/corporate bankers lack as compared to their counterparts in lev fin is the network of top PE funds?

But those credit/corporate bankers might still have connections to MM PE funds, no?

May 27, 2018
    • 1