Photographer: Luke Sharrett/Bloomberg

Direct Lenders Muscle Into High-Yield Territory as Funds Expand

  • Non-Standard Finance mulled bond before unitranche: sources
  • Faster execution, higher leverage may favor private debt deals

Direct lending funds in Europe are encroaching into the high-yield bond market as they target increasingly bigger financing deals, in yet another sign of the expansion of private debt funds in the region.

Heckler and Koch Inc., Non-Standard Finance Plc and Zenith Group Holdings Ltd. are among borrowers to have recently considered a bond sale but instead met their financing needs via a direct lender, according to sources familiar with the matter. By sidestepping the often lengthier and uncertain process of a public syndication, these companies secured access to guaranteed funds more quickly -- albeit with a more expensive debt solution.

“Direct lending funds have grown so big that they have become an alternative to an underwritten loan or bond deal,” says Floris Hovingh, partner and head of alternative capital solutions at Deloitte. “They are moving out of the traditional comfort zone of smaller mid-market deals and increasingly targeting 250-million-euro to 350-million-euro deals, which is the lower end of the high-yield and syndicated markets.”

For more on the growth of direct lending in Europe, click here.

The increased competition may further drain fresh high-yield supply in a market that’s seen net new issues dwindle as companies redeem more than they sell and refinance bonds with loans. In contrast, alternative lender deals have surged in Europe, with more than a thousand deals completed since the end of 2012, according to a Deloitte study. The market has also seen a 7 percent year-on-year increase in deal flow in the twelve months to March this year.

Head-On Competition

Alcentra’s 225-million-pound ($291 million) unitranche financing to the credit provider Non-Standard Finance last week is the latest example of this trend. The company, which will use the loan to finance the acquisition of George Banco and repay other debt, opted for private lenders after initially considering a bond issue, according to two people familiar with the matter.

The U.K-based borrower will pay 725 basis points above benchmark rates, which is within the typical premium range for the majority of deals provided by private debt funds, namely 600 to 800 basis points for unitranches. Though other non-bank lenders such as Jerrold Finco Plc have paid out similar premiums to bond investors this year, the Non-Standard Finance deal is above the average coupon of 4.3 percent for euro and sterling high-yield notes issued so far in 2017, Bloomberg data show.

In March buyout firm Bridgepoint ditched banks in favor of a 470-million pounds unitranche facility provided by Goldman Sachs’s private debt investment arm to support its acquisition of Zenith, a vehicle leasing business. Originally, the debt financing for the transaction was to be provided by HSBC Holdings Plc, Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc. The refinancing of Soho House’s high-yield bond with a loan totaling 375 million pounds from Permira is another example of how the public market is facing head-on competition.

Speed of execution, an ability to take higher leverage multiples and reduced financial reporting requirements and compliance costs are among the borrower-friendly aspects of private debt deals, according to a number of investors. The private route may also be an alternative for companies at the lower end of the high-yield rating spectrum, which are facing business-specific or sector challenges, they say.

German firearms manufacturer Heckler and Koch GmbH turned to HPS Investment Partners in July for a direct loan, according to sources familiar with the matter, three months after mandating Citigroup Inc. for a fixed income investor roadshow. The 150-million euro, covenanted facility will be used to refinance the company’s existing debt, currently rated CCC+ by Standard & Poor’s and B3 by Moody’s. In February, the firm’s bonds maturing in 2018 fell after it confirmed that it was being sued by a U.S. competitor.

Borrowers "might decide to pay slightly more and accept a leverage covenant to get a deal done," said Deloitte’s Hovingh. "In particular single B credits will be natural hunting ground for the direct lenders."

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