Hogan Lovells was a sponsor of this week's Creditflux/Debtwire European Direct Lending Forum and London leveraged finance partner, Jo Robinson, took part in a panel discussing the influence of large cap precedents on mid-market documentation. We have summarised some of the key themes emerging from the event.
While clearly there were concerns raised regarding the impact of the spread of COVID-19 on portfolio companies, there was a suggestion that disruption in the market may create opportunities for private credit, particularly in light of the lack of availability of finance from other sources, including the public markets. There was also speculation that this type of crisis could be the trigger for more differentiated pricing in European direct lending, with institutions pricing risk more accurately rather than being driven solely by market terms.
The general sentiment was that direct lenders in Europe are holding the line on including at least one maintenance covenant in deals but that the real question was around how effective those covenants are in view of the various adjustments and covenant testing provisions negotiated by sponsors. It was observed that there is more pressure on covenants as the deal size increases given the alternative sources of finance available to borrowers at the upper end of the mid-market where covenant protection is weaker, combined with the experience on documentation of both the sponsors who focus on those larger transactions – and crucially also their advisers. The other note of caution raised was that lenders may get comfortable with certain adjustments to EBITDA for covenant purposes – but are those appropriate in all places in the document where EBITDA is used as a reference point, such as margin ratchet, basket growers etc?
This clearly continues to be a significant factor in the European direct lending market. The relationships that debt funds establish with sponsors and management teams create the opportunity for a dialogue between lender and borrower that is often harder to achieve in the large cap space where multiple parties are involved, and this has benefits both in terms of allowing parties to focus on what really matters to them at the origination of a deal – even when that may involve a departure from precedent – but also, importantly, when things are not going so well. It was noted that sponsors are pushing for more controls on transferability of debt, even following an event of default, but that lenders in this market may get comfortable with that given they will generally look to work out a stressed loan themselves rather than transfer their debt in those circumstances (and there may be limited opportunities to find a buyer in any event). These relationships and the resulting ongoing communication was also identified in the discussion on "watchlists" as a way in which direct lenders can mitigate the impact of a potential deterioration in a borrower's performance since they are often able to identify and discuss issues at an early stage, creating more of an opportunity for the parties to work together to avoid a more damaging outcome.
The Hogan Lovells team has been at the forefront of the rapidly evolving global direct lending market since it was established in Europe, advising on all stages of the lending lifecycle – from the structuring and establishment of direct lending funds, through to advising lenders and borrowers on financing transactions, including regulatory and tax aspects. As one of the leading firms in this area, we have a strong track record of advising on unitranche and other direct lending products and work with our clients to develop new and innovative structures.
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