Middle Market Direct Lending

At $27 billion, quarterly syndicated middle market loan volume in the first quarter of 2021 was down 20% quarter-over-quarter and 15% year-over-year. The lower volume was partially a result of lenders recovering from the frenetic fourth quarter of 2020, during which $33 billion of loans were originated. Deal volumes picked up over the course of the first quarter, and March accounted for almost 60% of the quarterly loan volume. Deal volume is expected to remain healthy, as the middle market pipeline of $3 billion is in line with 2019’s level.

Only 44% of lenders surveyed were able to meet their lending targets in the first quarter given the lower level of originations, but the sentiment of banks and direct lenders differs significantly. 88% of banks were unable to meet their lending goals, while the level for direct lenders was 48%. Lenders that were able to meet their lending targets spoke to wide sourcing funnels, strong relationships with sponsors, and deal flow on par with the fourth quarter. Lenders that were unable to meet their targets spoke of competition for deals, aggressive lending terms, and competition from syndicated loans.

As borrowers continue to adjust to and recover from pandemic-induced business disruptions, lenders are continuing to see healthier portfolios. The share of non-bank lenders with 10-20% of their portfolios on a watchlist is down to 19% from 32% just a quarter before, and 32% reported that only 0-5% of their portfolio was on a watchlist—up from 12% a quarter earlier.

Given the pace of fundraising in the direct lending space in recent years, the supply of capital continues to outweigh opportunities for deployment, which has resulted in weaker lender protections in portions of the market. Two areas that reflect competitive pressures are LIBOR floors and maximum leverage. With 3-month LIBOR trading in its recent range, over 20% of the market has been willing to drop LIBOR floors to 0.50% from 1.00%. 50% of lenders are willing to lend at total leverage of 6.0x or more, whereas only 30% were willing to do that two quarters ago.

As we have long espoused, the direct lending market is extremely diverse, and performance will vary based upon manager approach, including EBITDA focus, position in the capital structure, sourcing avenues, and targeted industries. Looking ahead, we believe established managers that have consistently maintained healthy portfolios and stringent underwriting standards—particularly through the pandemic—and that have wide sourcing funnels, strong sponsor relationships, and robust deal flow will be well-positioned to grab market share during the period of lender consolidation that is expected over the coming quarters.

For more information on Middle Market Direct Lending, visit angelogordon.com/strategies/credit/middle-market-direct-lending/

Middle market loans continue to offer an attractive spread premium compared to leveraged loans. 

Using the global financial crisis as a guide, middle market sponsored issuance is expected to rebound further in 2021 after two strong consecutive quarters.

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