The reconstitution of the acquisition finance market following the financial crisis has created a larger and more diverse lender universe, with direct lenders transforming the market. According to Deloitte, direct lenders have done 1,937 deals in Europe since 2012, shifting the European acquisition finance space from one dominated by a handful of banks to a market more than 300 lenders are active. At a private breakfast briefing held before the Mid-Market 2019 debt conference a group of lenders, advisers and financial sponsors discussed what this transformation has meant for lender relationships, documentation and workout scenarios in the event of a downturn.

Monitoring the cycle

After a near decade-long bull market, stakeholders across the acquisition finance market are questioning if and when the cycle is likely to turn, and how any restructurings are likely to play out should a downturn arrive. Macfarlanes partner Peter Baldwin said it was impossible to predict how restructuring approaches would be affected, as each recession produced a different response. “Every phase of restructuring is different. Documentation and the levers lenders have available to them are different to those following the 2008 financial crisis. We are also looking at a market with a much wider pool of lenders with different interests. It will be intriguing to see how that plays out across multiple situations and jurisdictions,” Baldwin said.

Inflexion Private Equity’s Phil Edmans said that a different approach to assessing credits and cyclicality post-crisis pointed to a less volatile fall-out in the event of a recession. “There is a much keener focus on the credit this time and cyclicality is front of mind. Back in 2007 is wasn’t unusual to see cyclical businesses raising a lot of finance quite easily. You don’t see that now. The shift to the direct lenders means we are also looking at a very different pool of capital providers.”

Macfarlanes partner Jat Bains said that the fact that direct lenders have access to committed capital suggested a very different timeline to restructurings when compared to post-2007. “As direct lending funds are investing committed capital, it seems unlikely that exiting the market will be as fast as last time. At the moment funds are still able to raise capital that is locked in for a number of years relatively quickly. The thing to watch will be whether funds start finding it is more difficult to fundraise. That could be the first warning sign of a squeeze on liquidity.” Kirstie Hutchinson, also a partner at Macfarlanes, said the relationship-driven approach of the funds also pointed to potentially very different scenarios should assets land in workout situations. “This is no longer a market dominated by a smaller group of institutional bank lenders dependent on inter-bank lending for liquidity.

Direct lenders tend to be more aligned with their borrower community. They are also managing an asset and they care about protecting relationships, so the expectation is that they will be more incentivised to stay with an asset through the ups and downs rather than simply asking whether a credit should or shouldn’t stay on their balance sheet.” This view was echoed by Bain Capital Credit’s Alessandro Nussi: “A direct lender’s existence will be quite short-lived if it acts rashly. This is a longterm game where relationships, capital preservation and the patience to work through issues are essential.”

Alcentra’s Natalia Tsitoura, however, said although the direct lending model did facilitate a less reactive, more constructive approach to restructuring generally, track record and experience of working through downcycles remained essential. “It is a good time to raise capital, so there are a number of new entrants in the market but not many that have experience preceding the credit crunch. Over time we will start to see more defaults. That will impact track records and that could see a shift in fundraising,” she said.

Gambit Corporate Finance’s Jason Evans said this was a particular trend at the smaller end of the market and required monitoring. “We have seen a number of funds come in at the smaller end of the market and they have been doing several deals on bold terms. It will be interesting to see what some of those portfolios look like in the future.” Macfarlanes partner Andrew Perkins added that it would also be interesting to observe how direct lenders of different sizes responded to restructuring situations. “Bigger funds with bigger teams will have the infrastructure and scale to work through difficult situations. It is tougher if you have a small team that has to handle these credits at the same time as trying to maintain deployment,” Perkins said.

Cadence Advisory’s John Weeden said that once the market had moved through to the next cycle, the market may well have consolidated with fewer, larger direct lenders in control. “In my mind it makes sense that the more than 300 lenders we see in the market today will consolidate, as they will not all be able to deploy their dry powder as they wish. What we don’t want to happen, however, is to go back to the situation where the entire market was dependent on a handful of systemic lenders.”