The Unicrunch — refinancings and second liens

Peter Benson

23 August 2024•4 min read

The Unicrunch is our US private credit newsletter, in which we break down everything from unitranches to ABL lending. Find out more about 9fin for private credit.

Age of the refinancing

As summer comes to an end, there is hope that the M&A market can get back on track. 9fin’s inaugural private credit quarterly review found that the majority of activity in the private side of the debt market is looking internally.

In the upper end of the middle market — loans to companies with over $50m EBITDA — almost half of all issuance in the quarter went to refinancings. Around 30% of issuance in that part of the market was for recaps, repricings or other loans. By comparison, just over 20% of debt issued by private credit managers was for new leveraged buyouts or for M&A.

While it is still good for business to be deploying capital, much of this activity is at the behest of the borrower, the side of the equation with more leverage currently. The broadly syndicated market is back trying to poach credits from private credit (see Wesco) and private credit lenders are back at the table trying to keep loans in their portfolios. This is not the first time this year private credit has had to stave off banks either.

Consolidation is happening rapidly. Janus Henderson recently snatched up Victory Park to bolster its private credit capabilities while last month Blue Owl added Atalaya Capital Management to juice its asset-based financing business. With scale comes the pressure to grow or maintain market share thus forcing some refinancings to keep borrowers happy.

That said, they don’t always go to plan. Take M2S’ recent attempt at a refi and acquisition financing. The packaging solutions provider was looking for $870m in the BSL market but has since had to rope in direct lenders. The bank running the process, Jeffries, sweetened the deal for investors, offering a 93 or 94 OID, compared with 99 originally.

All told, private credit managers and banks are hopeful of the return of M&A to put new money to work. Until then, expect to see more refis.

Second best

One of the key takeaways from the BDC earnings cycle has been the shrinking market share of second lien in the private credit market. Some BDCs saw their allocations to the strategy fall to zero. Others went from the teens to the single digits as the structure simply falls out of favor.

There are a couple of key reasons for second liens falling out of favor with direct lenders, according to reporting 9fin published today. The growth in popularity in unitranche facilities has lessened the need for true second lien structures. That, and pricing compression has resulted in the gap between spreads for first and second liens coming in to the point it doesn’t pay the premium lenders expect for taking on the requisite risk of being behind lenders in the more senior position.

Beyond the obvious, there are some other questions lenders may want to ask when considering a second lien investment, some lawyers 9fin spoke to for the story said.

“Is senior debt willing to have junior debt behind it?” one lawyer asked. “And are they willing to allow that junior debt to have a lien?”

Where most first lien lenders will be comfortable is if the second lien is cash paying as opposed to amortizing, at least when the structure exists on a new deal, the lawyer noted. Beyond that, just making sure the intercreditor agreement is in a state where both the first lien and second lien are comfortable.

Even if things go well, lenders can often regret providing second lien debt, another lawyer said. “Second liens tend to be mispriced all the time,” they said. “Because you're making some positive assumptions to come in as a second lien, and the pricing isn't there.”

Ultimately it will be a while, if at all, that the practice returns for private credit. The unitranche that replaced the practice still maintains the top spot.