Middle Market Direct Lending
The syndicated middle market tallied $46 billion of originations in the second quarter of 2021, with volumes reaching their highest levels in three years. At $23 billion, new money lending was up 30% from the first quarter and at levels not seen since 2017. Refinancings accounted for $23 billion in the second quarter of 2021, almost double the total logged in the preceding quarter. Non-sponsored syndicated middle market loan volume amounted to $29 billion.
Increased competition is readily evident in loan pricing and acceptable leverage, as unitranche pricing has fallen below pre-pandemic levels. In the second quarter, unitranche loans averaged a blended spread of 586 basis points, 5 basis points below the previous low set in 2019 and 70 basis points lower than the spreads seen in the third quarter of 2020. Refinitiv’s most recent middle market lender outlook survey indicated that 23% of lenders were willing to finance borrowers with total leverage of 7.0x EBITDA heading into the third quarter. At the end of 2019, only 4% of lenders would go above 7% on a total debt-to-EBITDA basis.
Another sign of competition is that covenant-lite terms are working their way down to smaller borrowers. In Refinitiv’s third quarter 2018 survey, no lenders indicated a willingness to execute covenant-lite transactions for borrowers with less than $40 million of EBITDA. In contrast, the survey conducted during the second quarter of this year showed that 30% of respondents were willing to do covenant-lite deals with borrowers below the aforementioned $40 million threshold and 11% were willing to provide covenant-lite loans to borrowers with less than $20 million of EBITDA.
While the direct lending market is competitive, investors continue to allocate to the asset class. In the trailing 11 months ended June 1st, managers raised $91.6 billion across middle market CLOs, BDCs, and private credit funds, according to Refinitiv. That figure is down 10% from the total for the 12-month period ended March 31st, due in part to the number of dislocation funds raised during the second quarter of last year. The $21.3 billion raised by private credit managers in the second quarter of 2020 was nearly $7 billion more the previous second quarter record set in 2017. The $91.6 billion raised in the 11 months ended June 1st is 14% higher than the yearly total in 2018 and 38% higher than 2019’s total.
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On a trailing 12-month basis, direct lending fundraising remains near historic peaks at $101.9 billion as of the end of Q1 2021. Commingled fundraising remains the primary format, representing over 80% of capital raised.
Unitranche spreads have retreated below pre-pandemic levels and are approaching 2019 lows. Covenant-lite unitranche loans are another sign of competition in the market.