On the surface it was a classic leveraged takeover — $1.8 billion of debt to fund the acquisition of Gannett Co. And just like hundreds before it, front and center was Apollo Global Management. Except this time, the private equity giant wasn’t the borrower. It was the lender.
The deal is part of a major shift occurring in global finance. Direct lenders, including more and more hedge funds and buyout firms, are preparing to dish out billions of dollars at a time to lure borrowers away from the $1.2 trillion leveraged loan market.
It’s the latest push by alternative asset managers into what was once the exclusive territory of the world’s biggest investment banks. And while Wall Street voluntarily ceded much of its business lending to medium-sized companies in the aftermath of the financial crisis, this time the iron grip it has on arranging the industry’s bigger loans is being pried open, jeopardizing some of its juiciest fees.
“Direct lenders have raised significant capital to allow them to commit to larger deals,” said Randy Schwimmer, head of origination and capital markets at Churchill Asset Management. “It’s an arms race.”
It’s a striking reversal of fortune for syndicated-lending desks that spent the last 10 years luring business away from the high-yield bond market, the original source of buyout financing for big, risky companies. Even as recently as the beginning of the year, deals in excess of $1 billion were largely seen as the private domain of bulge-bracket banks, which arrange and sell them to institutional investors.
Not anymore.
Apollo said last month that it’s looking to do deals in the $2 billion range. Rival Blackstone Group Inc. is actively pitching a trio of billion-dollar financings that it intends to hold entirely itself, according to a person with knowledge of the matter. (The firm declined to comment.) And private-credit standouts including Owl Rock Capital and HPS Investment Partners are also setting their sights on bigger loans.
The August financing of New Media Investment Group Inc.’s acquisition of Gannett came on the heels of a $1.25 billion direct loan by Goldman Sachs Group Inc.’s private-investment arm — one of the few of its kind under a Wall Street bank — and HPS to fund Ion Investment Group’s purchase of financial data provider Acuris.
And in October, a group of about 10 lenders including Owl Rock banded together to provide a $1.6 billion loan to refinance the debt of insurance brokerage Risk Strategies.
“There are bigger pools of capital” now, said Craig Packer, co-founder of Owl Rock, which controls more than $14 billion. “Our holdings of individual loans are therefore larger than was previously available from smaller lenders.”
Fading fees
Investors have plowed hundreds of billions of dollars into private debt funds in recent years, lured by premiums that are more than five percentage points higher than competing public debt, according to a Goldman Sachs analysis.
Assets under management now exceed $800 billion, based on the most recent data available from London-based research firm Preqin, including over $250 billion of dry power. In contrast, leveraged loan growth has begun to stall, with the size of the U.S. market now hovering around $1.2 trillion, up less than 4% from a year earlier.
Partly as a result of direct lenders increasingly allowing borrowers to bypass the syndication process, compensation for arranging leveraged loans has plunged. Fees are down 29% this year through November, to about $8.5 billion, versus the same period last year, according to Freeman Consulting Services estimates.
The biggest players in the industry say the shift is just getting started.
Apollo predicts as much as 10% of the more than $2.5 trillion high-yield loan and bond market will go private over the next five years, John Zito, co-head of global corporate credit, said at the company’s Nov. 7 Investor Day.
The alternative asset manager sees the privatization of global credit mirroring a similar trend that’s swept equity markets in recent years.
In fact, many say the continued expansion of private equity will only help fuel the growth of direct lending.
“As private equity capacity increases, more deals and larger deals are being done in the private space,” Benoit Durteste, chief executive officer of Intermediate Capital Group, said in a report by the Alternative Credit Council last month. “This is why we are seeing larger and larger deals in private debt and the limits keep on being pushed.”
Growing execution risk in the leveraged loan market is also prompting buyout firms to increasingly turn to private sources of financing, according to market participants.
Loan buyers have been drawing a line and either bypassing or demanding significant concessions to lend to companies that may struggle in an economic downturn. On the flip side, private debt transactions can often be arranged in a fraction of the time it takes for a public-market deal, while limited scope for pricing adjustments provides sponsors with greater cost certainty.
Yet efforts to win deals away from investment banks, along with growing competition among direct lenders looking to deploy more than a quarter-trillion dollars of pent-up cash, have some worried about weakening lending standards in the industry.
The club loan to Risk Strategies boosted the company’s leverage multiple to seven times a key measure of earnings, as much — if not more — than the issuer would have been able to get away with in the leveraged loan market, according to people with knowledge of the matter. While the financing includes a maintenance covenant, its terms are loose enough that the company would likely already be struggling to meet interest obligations before the safeguard is triggered, said the people, who asked not to be identified because they aren’t authorized to speak publicly.
“We are worried about how much debt has gone there versus going to the public market, and what that means in a downturn because there’s no liquidity” in private credit, said Elaine Stokes, a portfolio manager at Loomis Sayles & Co. in Boston. “That could seep into the public markets, if you end up having people becoming forced sellers.”
For others, the growth of direct lending is simply part of the natural evolution of credit markets.
“It’s part of a broader harmonization,” said Jeffrey Ross, chair of Debevoise & Plimpton’s finance group. “The broadly-syndicated loan market for the past 10 years has evolved to look and trade like high-yield bonds. There’s been a similar convergence between the middle-market and bulge-bracket lenders.”
