Worse still, covenant-lite debt packages mean that lenders can do sod all about it. 

“Borrowers enter default territory at a late stage,” points out law firm King & Spalding in its very interesting paper, essentially a ‘how-to’ guide for lenders to claw back control of their borrowers. 

How to trigger default as a private credit lender

Use LMA documents to establish misleading or inaccurate representations by the borrower, urges the paper. This may help the lender constitute events of default. King & Spalding also suggest lenders review their forward-looking disclosures, and to make full use of their ad-hoc information rights, for example, requesting presentations, in order not to be the last to find out bad news.

Crucially, the LMA facility agreement includes a ‘material adverse change’ event of default, triggered if an event occurs that the lender reasonably believes will affect the borrower’s loan obligations. In the absence of covenants, these, K&S argue, can be used to trigger the necessary event of default.

Psst…how to keep the borrower at arm’s length

On the other side of the coin, law firm White and Case reveals this week how sponsors should take advantage of every bit of flexibility in the docs. This includes maximising any adjustments to EBITDA and net income permitted in the loan agreements (notoriously loose in the past few years). 

Other flexibility includes interest rate margin step-downs (which allows a borrower to reduce its interest costs) and excess cash flow sweep percentages (which allows a borrower to allocate a smaller proportion of their free cash flows to pay down loans) if leverage levels are lowered. 

Adjust financial metrics, the message goes, “and doing so before a covenant testing event or another potential transaction puts borrowers in the best position possible to manage their capital structure, avoid default and preserve flexibility going forward.”

But for lenders, putting off defaults only exacerbates the problem. 

As law firm Proskauer points out in its covenant deep dive: “The worst-case scenario for a lender is one in which performance has declined to an extent that [the sponsor has disengaged] but there is still just enough liquidity for management to avoid a payment default or insolvency process.” 

“In this situation, lenders can end up being forced to sit on their hands while the situation deteriorates further, which can materially reduce their recoveries once a default does indeed finally occur.”

KKR, ABL and…Paypal?

Aha, we have finally figured out what’s up with KKR. A month ago they wrote an interesting paper extolling all the virtues of asset-based lending. Asset-based finance: A fast-growing frontier in private credit. This, it turns out, was just warming us up for the main event, which was revealed this week to be an up-to $40bn entry into ABL with the purchase of Paypal’s buy now, pay later receivables in Europe. The purchases will be funded by private credit funds and accounts managed by KKR.

What?

As pointed out in this week’s 9fin’s Excess Spread column - “it’s…one of the most dramatic illustrations of the sheer power and scale of the private asset-backed business today.”

Asset originators have not historically relied on private market solutions. However, the current volatility in the securitisation market is pushing asset originators towards a wider range of funding solutions, and, as with the retrenchment of banks in 2008, could ultimately be the beginning of a shift towards private asset-based lending solutions.

And the money’s there. We’re no strangers to the amount of capital in private credit ($1.4trn on Preqin’s last numbers), nor are we any longer surprised by the $bn plus deals taking place on both sides of the Atlantic nor entry into humongous P2P debt (Dechra). 

Dry powder in private credit (see slightly overused chart, below) can’t all be absorbed by the EBITDA-secured corporate loans under which private credit made its name. First of all, the deals are not there thanks to the M&A drought, while the jumbo deals of $5bn that looked promising either didn’t happen (Cotiviti) or are still ongoing (Finastra).

Cue entry into ABL, which, albeit, is huge.

There is also an important diversification angle. Corporate private debt secured against EBITDA has converged around the software, healthcare and IT sectors thanks to these businesses’ ability to throw off visible annual recurring revenues. Private debt has also taken increasingly large tickets in single deals, creating a concentration risk both in sectors and in single businesses.

ABL allows for some diversification. As Castlelake pointed out at the beginning of this year, investments backed by hard and financial assets often generate front-loaded principal payments which reduce the cost basis, while the self-amortising nature of asset-based lending shortens the duration of investments and broader market correlation. 

KKR’s $40bn war chest is at the moment targeted on Paypal’s European BNPL receivables. In their paper, however, consumer finance is but a fraction of where they see the opportunity. Hard assets, contractual cash flow and commercial finance are all there too. 

If we’re to take this paper as a KKR statement of intent, then anyone looking for financing in these areas will be rubbing their hands together with glee. Private credit’s coming for you.

Carve outs and refinancings

Carve-outs aplenty. Carve outs are a tricky kind of acquisition to finance for private debt, as its about imagining the standalone business. Unsurprisingly, 9fin writes that Souter Investments and Sullivan Street Partners’ acquisition of Johnson Matthey’s Diagnostic services business Tracerco was financed by highly specialised debt provider of opportunistic capital North Wall Capital.

“Carve out businesses spend a lot of money getting separate from their parent entity so flexible capital and a partnership relationship with the lender is essential,” said a source familiar with carve-out deals.

Another carve-out announced this week was that Palatine has backed growth at waste management company Roydon, which is carved out of the Roydon Group.

Sullivan Street’s Tivoli Group has also made a bolt-on acquisition, highlighting the importance of buy and build strategies at the moment.

In Spain, Pricoa Private Capital is refinancing a €65m term loan provided only in January to Apex Group-owned Spanish football club Real Betis Balompié.

Meanwhile, yet another software deal as Investec provides senior debt facilities to support August Equity’s investment in StarTraq. 

In the fundraising world, HSBC’s UK direct lending strategy has now reached $1.7bn of commitments received to date across the strategy and associated mandates. 

This, according to a LinkedIn update, follows the successful launch of the second vintage with a total fundraise of $580m including associated mandates. 

Due to private equity not wanting to over gear businesses in a high interest rate environment, “lenders like HSBC are becoming more active, competing with funds, offering stretched senior bullet structures and can hold £70m, maybe even more,” a debt adviser told 9fin.

Something missing? Want your deal in here? Contact me josie@9fin.com