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How has COVID-19 changed middle-market lending?

Matthew Toole
Matthew Toole
Director, Deals Intelligence

What are the new frontiers in the world of lending to middle-market companies? We recently heard from four leading investors and debt providers at the LPC spring conference, and here are their key observations on middle-market lending.

  1. Middle-market lending saw a full debt cycle in 2020, with lending standards reportedly looser now than 2019.
  2. Portfolio-lending performance remains “surprisingly” positive.
  3. Diversity of private credit strategies means lenders are better able to find profitable niches.

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There was a consensus that 2020 saw an incredibly fast lending cycle, from the benign borrowing environment that prevailed pre-pandemic, through the crisis-management and portfolio-triage during the second and third quarters, before bouncing back to an even hotter market than previously, before the year was out.

Middle market: new frontiers. How has COVID-19 changed middle-market lending?

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As a result, many parts of the debt capital market are now “frothy”, with looser terms than at the end of 2019, and there is a trickle-down effect into the mid-market. The “white-hot” syndicated loans market has driven unitranche lenders into the mid- and lower mid-market, loosening terms.

The push-down does halt eventually, with smaller sponsored deals in the $10m-$30m range remaining relatively insulated in terms of covenant-lite drift.

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Resilient portfolios

Meanwhile, all the lenders reported surprisingly positive resilience within their existing portfolios.

Sometimes this was a function of luck – having avoided those sectors worst hit by lockdowns, but it was also a result of the huge government-backed liquidity pumped into the market, which was “a very successful programme.” This, in turn, encouraged the private sector to turn the taps back on.

Not everyone turned the taps off, of course.

Contrarian lenders enjoyed a short window where they could move quickly and deliver facilities to companies in need, without being too fixated by pricing-perfection. There have also been ‘special-situation’ opportunities for private credit, particularly in the non-sponsored space, where corporate leadership teams might not be so capital-market savvy and require an “institutional bridge” to recover or hit their next valuation milestone, without raising dilutive equity.

Asset-based lending

In the more traditional parts of the market, such as asset-based lending (ABL), there was only ever a marginal impact on lending terms, back to pre-pandemic conditions. Taken in the round, it was a strong year for ABL, particularly since it tends to focus on sectors that were relatively insulated from lockdowns, such as distribution and agriculture.

Even racier parts of the lending space, such as venture debt, have weathered the turbulence, with portfolios even benefiting from a rapid adoption of technology-related services. Meanwhile the SPAC boom has fuelled venture capital exits that, in turn, also provide a liquidity event for lenders.

The non-financial nature of this recession made it exceptionally difficult to plan for.

Asset-based lending was marginally impacted, on lending terms, by the COVID-19 pandemic in 2020. How has COVID-19 changed middle-market lending?

Instead, lenders emphasise the importance of communication – with a strong consensus that the level of transparency and willingness to engage in an open dialogue, between borrowers and lenders, has been widely positive.

For all lenders, borrower education is an ongoing requirement, whether it is explaining the merits of dealing with one counterparty, the reasons to entertain a higher cost-of-capital, or simply the time-value of short-cutting the prolonged process of dealing with traditional lenders.

The future of middle-market lending

The middle-market private lending space advances into 2021 having come full circle, and finds itself in a prosperous, albeit super-competitive, environment.

Such is the specialisation in the market – from sponsored, to non- or independently-sponsored deals, venture financing, cashflow or asset-based lending, and even royalty-based solutions – the availability and profitability of private lending opportunities appears both more resilient and less correlated with macro-trends than the casual observer might expect.

Or to put it another way, if 2020 couldn’t stop it, what can?

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