Middle Market Direct Lending
Total U.S. middle market loan volume across the syndicated and direct lending markets, including non-sponsored activity, amounted to $203 billion in the first nine months of 2021—18% above full year 2020 levels and only 12% behind full year 2019. Sponsor-backed middle market lending totaled $48 billion in the third quarter of 2021—up 14% quarter-over-quarter—making it the second-busiest quarter recorded, trailing only the $50.2 billion originated in the second quarter of 2018. The third quarter also saw a record-high 401 sponsored middle market deals.
Increased competition is readily evident in loan pricing and acceptable leverage. In the third quarter, the spread on unitranche loans decreased for the fifth consecutive quarter; at 5.83%, the spread was lower than the average spreads seen in 2018 and 2019. While the 55% of lenders accepting borrowers with leverage greater than 5.5x EBITDA is lower than last quarter’s 69% figure, the percentage of managers willing to lend at leverage multiples above 7.0x EBITDA remains elevated at 23%. At the end of 2019, only 4% of lenders would go above 7.0x on a total debt-to-EBITDA basis.
While the direct lending market is competitive, investors continue to allocate to the asset class. In the trailing 12 months ended September 30th, managers raised $53.5 billion for U.S.-focused direct lending strategies, according to Preqin. That figure is $17 billion above the pre-pandemic high of $40.2 billion seen in the third quarter of 2018. Allocations have continued to flow to a smaller number of funds; 34 funds closed in the 12-month period ended September 30th, 2021, which is 11 fewer than the 45 funds closed in the peak twelve-month period ended June 2019. The average size of closed direct lending funds has increased 94% to $1.575 billion over that time.
As the amount of direct lending capital raised has increased, so has dry powder in the lending market. The amount of dry powder in the direct lending market, however, continues to trail the volumes found in the U.S. buyout market. Preqin’s recent numbers suggest that there is almost $600 billion of dry powder in the U.S. buyout market, while the amount of dry powder in U.S.-focused direct lending is approximately $80 billion.
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Middle market loan volumes through September have surpassed full year 2020, and non-syndicated deals represent more than 60% of the sponsor market.
The number of sponsor-backed deals reached record levels in Q3 2021, and loan volumes hit levels not seen since Q2 2019.
On a trailing 12-month basis, the amount of capital raised has increased every quarter since Q4 2020, but capital has been raised by fewer managers.
Dry powder in direct lending is approaching $100 billion, but it trails the dry powder in U.S. buyout funds by over $500 billion.