February 10, 2020 - On February 6th, the LSTA hosted the second part of its Direct Lending Webinar Program which was presented by James Florack and Jeong Lee of Davis Polk, Vikas Keswani of HPS, and George Mueller of KKR. On the best day, the execution of a deal in the syndicated loan market is still likely the best option for a borrower; however, because predicting or timing the market is tricky, direct lending is an attractive alternative for many borrowers, for it offers certainty of timing, price, and terms, while avoiding the longer syndication and ratings processes of the traditional syndicated loan market. For some borrowers, the virtues of “clubbing up” a deal with a small handful of lenders is preferable, offering opportunities for meaningful dialogue amongst the lender(s) and borrower from the diligence phase to structuring the deal through execution.  Furthermore, direct lending offers structural advantages for an acquisitive company with a need for delayed capital, because the delayed draw loans in the direct lending market typically extend further than in the syndicated loan market and offer lower ticking fees.  Even if a company does not want a delayed draw feature, a borrower seeking additional capital will find that the process of dealing with the direct lenders is less onerous, and because these loans generally don’t trade in the secondary market, concerns about MFN provisions or fungibility of incremental loans no longer weigh on the borrower’s mind.  Direct lenders report that they can be more constructive in complicated scenarios and can more effectively handle foreign jurisdictions in a thoughtful manner, easily capable of funding in liquid currencies, structuring co-borrowers, and structuring to take advantage of tax deductions in different jurisdictions. 

The timing to review documents in the syndicated loan market can impose significant pressure on potential lenders who may be forced to skip steps in the document review process in order to meet imposed deadlines.  By contrast, direct lenders engage counsel directly and report that the more rigorous diligence process at the outset (which offers greater access to a company’s management and confidential information), the thoughtful borrower / lender conversations, and the careful review of credit documents translate into a deal that has been customised for the  borrower, with the lenders more cognizant of the borrower’s business and its demands. Direct lenders report that customised deals will often translate into tighter, better lending terms.  Most direct lending deals include a financial maintenance covenant so EBITDA will be a carefully crafted term, with the earlier diligence informing the allowed (or disallowed) addbacks and any caps. Only a small percentage of direct lending deals are covenant lite and even these deals will be balanced by tighter terms elsewhere in the credit agreement and may, for example, include real amortization or cashless sweep features and also may tend to have lower leverage levels. Because direct lenders rarely trade out of a loan, they argue that this generally ensures there is a clear understanding amongst lenders and borrower of what is in the collateral package and what can move in and out of that package; generally, direct lenders are more circumspect around a borrower seeking flexibility to manage its subsidiaries and business.  Thus, the loophole provisions that have crept into the syndicated market are generally not found in direct lending.  If a borrower becomes distressed, discussions that take place may be more intimate, transparent, and straightforward with some borrowers reporting that direct lenders are more supportive in times of stress, with no unfriendly lenders having been able to buy the loans in the secondary.  Click here for the replay.

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