Direct Lending market booms on the back of deal and merger activity

24 October 2016 Consultancy.uk

Direct Lending alternative finance hit $37.3 billion last year, as companies across the globe hike their search for additional channels to fund growth strategies and M&A activity. The UK remains a dominant player in the sector, with 327 deals to the rest of Europe’s 457 deals over the past three and a half years. While activity remains relatively robust into 2016, the alternative finance market may find itself in downturn as risks increase.

The alternative finance market has in recent years grown considerably across the UK – according to a study by the University of Cambridge, Nesta and KPMG, the market today is worth £3.2 billion, up from £666 million in 2013. The market is being lifted by, among others, the growing popularity of non-bank solutions and the currently low interest rates, which makes lending relatively cheap. 

A new report, by Deloitte, finds that in the mid-cap market alternative finance space, Direct Lending continues to see strong demand from particularly UK-based companies. The study, titled ‘Entering New Waters: expanding beyond the mid-market’, tracks the developments of 47 major European alternative finance lenders, such as Ares, Bain Capital and Tikehau, for a snapshot of activity across the continent and the UK.

Global direct lending fundraising

Global direct lending fundraising

Last year alternative finance lenders completed more than 600 deals, with deal activity hitting $37.3 billion, up from $22.7 billion in 2013. Among the largest funds that have reached financial closing in 2015 are the $3.3 billion Ares European Loan Programme, the $3 billion ICG Senior Debt partnership II, and the $2.4 billion Park Square Capital Credit Opportunities deal. Across Europe, the Direct Lending market saw just over $15 billion in registered deal activity.

In terms of the sectors leveraging Direct Lending deals across Europe, Technology, Media & Telecommunications and Healthcare & Life Sciences saw the largest number of deals at 17% each, followed by Business, Infrastructure & Professional Services at 14%. Human Capital, Retail and Financial Services took the least interest in Direct Lending at 1%, 2% and 4% respectively.

Deal purpose

The UK market shows a relatively similar pattern, with Technology, Media & Telecommunications on top at 18%, followed by Business, Infrastructure & Professional Services at 16%. Leisure however, came third at 11%, while Healthcare & Life Sciences took the number four spot with a 9% share. 

In terms of the reason for companies leveraging Direct Lending opportunities, the vast majority were linked to M&A activity – in the UK this stood at 45% of deals, while in the rest of Europe the percentage amounted to 53%. Refinancing too took a considerable slice of Direct Lending activity, at 25% in the UK and 27% in the rest of Europe. Dividend Recapitalising came in at 16% in the UK and 6% in the rest of Europe, representing the largest discrepancy between the UK and its mainland neighbours.

Deal structure

Unitranche was the most commonly leverage loan type in the UK, at 47% of Direct Lending, whilst in the rest of Europe senior structure is more dominant with 39% utilisation. The high level of first lien leverage, at 73% across the region, reflects that alternative lenders are competing mainly with banks. Mezzanine lending saw a 9% share of utilisation in the UK and 8% in the rest of Europe, while payment in kind (PIK) saw 6% utilisation in the UK and 10% in the rest of Europe.

Funding risk profiles

The analysis also looked at the wider funding arena, which includes a range of debt products across a several institutions. The research finds that investment grade bonds represent a large area of funding that offers relatively large debt sizes at high credit worthiness, this is followed by senior bank loans, bilateral & syndicated, offering a range of risk profiles for relatively large debt sizes. Private placements provide higher risk lending for lower loans sizes, while high yield bonds offer high debt sizes for higher risk profiles. Direct Lending has a similar risk profile to high yield bonds with a lower loan size threshold.

Return to normal

The growth in the market for Direct Lending, as with other alternative finance options, may be relatively short lived as rates increase and risk profiles for loans may return to long term trends – boosting bank offerings and creating too much risk for investors that can make gains in other quarters of the economy.

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