Taking the Credit — Direct lenders crank terms tighter

Josephine Shillito

24 March 2023•3 min read

The primary private credit market continues to make its shy comeback, after a faltering start to the year. At least two deals have been announced in the past week, and even a couple of European LBOs — with €3-€4bn of debt — are knocking at direct lenders’ doors.

However, behind the scenes lenders are taking a dim view of terms, many of which feel dangerously loose as the winds of volatility pick up.

“It’s a terms issue,” said a direct lender operating in large club unitranches. “Previous conditions just won’t wash anymore.”

Two particular areas in the spotlight are most-favoured nation (MFN) clauses, and rules around how EBITDA is calculated. As we’ve reported, over the pond lenders have increasingly been agonizing over the fine print in new deals; that trend is now impacting European primary activity.

Case in point: business management software provider Access Group has struggled to woo lenders with its £500m add-on (accessible to 9fin clients), partly because of a missing covenant. And the 12-month MFN the borrower offered last year now appears rather stingy to existing lenders, as the add-on offers an extra 100bps.

Everything-adjusted EBITDA

As for EBITDA definitions, these are also giving funds a headache. With the aftershocks of Covid still reverberating on supply chains and the Ukraine war playing havoc with energy prices, some lenders are finding existing caps on EBITDA insufficient to protect their interests.

“The context of EBITDA add-backs, and the capping of add-backs, all merits greater control,” said another direct lender.

Sources gave examples of the exceptionally high energy costs of 2022 being added back onto EBITDA in the form of unabated costs. They also noted how important it was to maintain and enforce these caps.

Again, the US has provided some live examples. Lenders working on the record $5.5bn unitranche for Cotiviti’s buyout by Carlyle appear to have won a 35% cap on add-backs (accessible to 9fin clients) to the healthcare tech company’s EBITDA. Sources tell us the deal was heavily oversubscribed, but the club’s win on EBITDA suggests that even so, lenders still have some negotiating power.

Elsewhere in the market, technology and analytics service provider Kpler has succeeded in securing €87.5m of senior secured first lien financing — underwritten on ARR rather than EBITDA — from Bain Capital Credit and Apax Credit. The company is backed by Five Arrows and Insight Partners.

Solutions in secondary

As the declining value of bond portfolio continues to amplify the denominator effect, there is no shortage of LP-led secondary activity.

This week, 9fin reported Tesco Pension Investment’s attempt to offload its private markets exposure through a third-party broker. These types of sales can often be highly intermediated, as the LP fights to release as much cash as possible while still gunning for the best price.

However, a significant chunk of secondary liquidity also comes from bilateral sales led by GPs — banks in particular.

“As banks move towards a fee-driven, rather than balance-sheet driven model, we’re seeing a lot of appetite from banks to create single managed accounts for some of their lending exposure,” said a source active in the private credit secondary market.

This takes the loans off the banks’ balance sheet and into a fund; meanwhile the bank can take a role similar to a private credit GP and manage the SMA in partnership with another private credit firm.

Speaking of banks, let’s hope we get through the weekend without any more bank runs. See you next week.