Lenders introducing more flexibility to loan docs to beat competition
The rising competition amongst private debt funds in Europe is impacting lender protections.
Although cov-lite lending – a common feature of the larger-cap market – has not become prevalent in the middle market, there has been price erosion as well as an impact on documentation.
“A lot of the documentation changes that were made in 2022 and the early part of 2023 to the benefit of mid-market lenders, are starting to be clawed back by sponsors and borrowers as a result of this increased competitive environment,” said Marc Chowrimootoo, managing director at Hayfin Capital Management.
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He says he has seen competitors expand the list of adjustments and add-backs to EBITDA, with some including revenue synergies, among other things, and others including longer time periods for realisation. Hayfin Capital Management has been trying to keep that period to 18 to 24 months while others have increased it to 36 months or longer.
In addition, the percentage of add-backs is also expanding to, around 25 per cent now, with Hayfin fighting to keep it as low as possible.
Add-backs to EBITDA entail removing – or adding – operating expenses to create an accurate view of the business’ historical and future profitability.
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“We’re still trying to be very disciplined in making sure for example that EBITDA add-backs are as limited as possible and are capped at an absolute sensible percentage,” Chowrimootoo explained.
“And we are still trying to hold the line on other things we care about, things which are core to the credit thesis, making sure debt incurrence levels are being set at sensible levels, being disciplined around the size of committed acquisition facilities (CAFs) and the ability to move assets out of the group.”
Chowrimootoo has seen the size of CAFs increase over time, where one deal Hayfin did not participate in had three turns of EBITDA as the size of CAFs.
Another thing Hayfin has been pushing for is covenants that gradually step down to provide credit protection over time, but many of its peers have been offering flat covenants. Headrooms on loans have also moved higher from 25 to 35 per cent in 2022 to 2023, to 35 to 40 per cent this year.
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According to Richard Olson, managing director at Lincoln International, given the depressed volumes in new deals there is much more competition amongst lenders for those. Therefore he has seen more generous covenants, going back to where they were prior to interest rate hikes. While refinancing deals have trended to be slightly tighter, these are also moving closer to what is seen in newer deals, Olson said, as competition from the broadly syndicated loan market increases.
One positive note on the direction of covenants is the increasing prevalence of ESG margin ratchets. Chowrimootoo says he is seeing those more consistently now amongst peers.
“We actually think this is a positive development provided the KPIs selected, their definition and the reporting around those are sufficiently meaningful,” he added.
