CJ Doherty: Welcome to the Lending Lowdown. I'm CJ Doherty, director of analysis at LSEG LPC. And in today's podcast, we're gonna focus on US direct lending in what I'm happy to say is our 20th podcast in the series, direct lending, given its private nature, is a market where information is not readily available and access to data varies across market participants. And so official year end numbers don't come out immediately at year end. It's always a few weeks before all the relevant data has been collected and analyzed, and we hear at LSEG LPC, who are at the forefront of this market, recently published our year end report. And we also published the results of our Outlook survey. And so to discuss the findings and give us an idea of what's in store as we look ahead, I thought it would be a good idea to bring in my colleague, Dave Puchowski, who was also a director of analysis here at LSEG LPC and produces much of our analysis in this space. Dave, thanks for joining me.
Dave Puchowski: Thanks for having me, CJ. Happy to be a part of the 20th episode.
CJ Doherty: Great great. And so let's dive right into it.
CJ Doherty: What were the key trends in the direct lending market in 2023?
Dave Puchowski: Yeah. So just want to preface that we're we're talking about the US private equity backed direct lending market, that's the focus of my coverage with private credit and and total volume there was 187 billion last year, which was actually the third highest all time behind 21 and 22. So, not too shabby, but it was 16% lower year on year. Now the syndicated loan market was really hit in, in 2022. That was when that market saw dislocation, but the direct lending market pretty much kept on going that year. So it wasn't really until 1Q 23 that we saw direct volumes far lower than where they had been. But the good news is that volumes increased throughout each quarter of the year and and that culminated in 4Q 23 totaling over 80 billion, which is the most since 4Q 21. So ended the year a lot stronger than where it started.
CJ Doherty: OK, great. And can you shed more light specifically on deal mix in 2023 and also dig a bit deeper into M&A?
Dave Puchowski: Right. Well, M&A was certainly lower. You know the difficulty for buyers and sellers to come together spanned across markets when the market dislocates, there's going to be some valuation differences of opinion between buyers and sellers. And I think that was, you know, further complicated by the fact, you know, we're still close enough to the COVID years where there's still some opaqueness to, to what an accurate EBITDA measurement even is. So if you add that all up, we saw 41% decline and direct lending LBO volume last year, tuck in acquisition volume was down less dramatically 24% and you know that lines up with what lenders had repeatedly told us last year that that a lot of activity was centered around portfolio churn rather than new buyouts.
CJ Doherty: Yeah. And we saw a shift towards direct lenders in the LBO market last year, didn't we?
Dave Puchowski: Yes, absolutely. And and probably what's most interesting in this M&A conversation is that despite LBO activity being a lot slower last year is how much of that volume went to the direct lending market. We saw a serious pullback in the syndicated market. LBO volume is down 65% and and that was because of execution risk and lack of demand from investors for lower rated credits. So you know when all the dust was settled, 59% of total US LBO loan volume was done in the direct lending market and that was the first time that direct you know took the majority over the syndicated market. So it's definitely a fascinating piece of this conversation.
CJ Doherty: OK. And let's talk about the pricing side now then you know where did pricing moved directionally in the fourth quarter of of 2023 and what levels did you see there?
Dave Puchowski: Well spreads have come down from peaks we saw in the first half of last year. Unitranche blended spreads averaged a little over 600 basis points last quarter compared to 690 in 1Q 23. So it's come down quite a bit and and really is only about 25 to 30 basis points over 2021 levels. So they're not far off of those bull market levels. As as far as minimums, we ask in our quarterly survey, you know what's the minimum unitranche spread you would execute on and for 1Q 24 lenders answered 525 to 550 would be the lowest they would go on a uniblended spread. Now that's the larger players in the market, you know, lower middle market that minimum threshold would be higher, but you know, even though spreads have come down, yields are still very high, at least in the middle market where where we have a lot of coverage for direct lending, yields were over 12% last quarter. You know, for for what was between 7 and 8% range back in 21.
CJ Doherty: Yeah. So still a pretty juicy yield there for for lenders, which is good.
Dave Puchowski: Yeah.
CJ Doherty: And staying with the topic then of pricing the broadly syndicated market you know has seen a surge in repricing activity in January. Have you seen any knock on effect in the direct lending market?
Dave Puchowski: Right, probably the the number one headline in the loan market so far this year has been this repricing wave in the broadly syndicated market. You know, direct lending isn't really an opportunistic refinancing market in that we wouldn't see these big waves of activity similar to when these windows of opportunity open up like in the BSL market currently. But I will say there was a greater share of refinancings in the direct lending market last year. And you know, even last quarter we saw a surge in larger unitranches and part of that was due to refinancing activity. The other wrinkle to this current wave of BSL repricings is that there has been a few that came from the direct lending market. So sponsors are dual tracking the two markets and and some are opting for the cheaper spreads being offered in the syndicated market. And I think you know that you know, direct lending versus syndicated market dynamic will be an interesting one to watch throughout the year. Those LBO deals that I mentioned earlier that were going to the direct lending market last year, well one of those just repriced into the BSL market. So you wonder if this will turn into more of a trend and whether the syndicated market can claw back some market share with some of these repricings.
CJ Doherty: Yeah, definitely something to to keep an eye on as as we progress this year and let let's look ahead now. You know, in in our recent Middle Market Outlook Survey, lenders were asking what will be the biggest themes in the loan market in 2024. What were the main takeaways here?
Dave Puchowski: Yeah. So we we asked that question and and the answers can really run the gamut. But if I had to crystalize some of it, I'd say it was heavy on interest rate related responses, with most saying how the expected cuts will improve market sentiment in the back half of the year, assuming the cuts start happening as expected. We already saw how market sentiment improved once it became clearer when the hiking cycle would end, one lender told us in December. He was relieved he hadn't had a conversation in about 8 weeks of the bar, were about a hard landing scenario, so I think rates were probably the number one theme. Obviously, M&A activity is correlated with that and that was also mentioned to see M&A activity pick up. Uh, you know, once rates start getting caught in, overall market sentiment improves. Uh, you know? Then on the flip side, some of some of the less optimistic responses were also around interest rates and the dot plot and you know they expressed concern about the cuts not going as planned and how you know higher for longer rate environment can play out. So you know, we're certainly not in any sort of full throttle ahead mode, but there was certainly more optimism about 2024 even if it was more targeted for the second half of the year. You know, certainly more optimism optimism than than when we saw, you know, heading into 23.
CJ Doherty: Yeah, I want to switch gears now for for the final topic. You know, loan portfolios have held up, you know pretty well across the market which which is good news. But in the recent Middle Market Survey, I know you asked both direct lenders and banks, what are the biggest stressors on issuer performance that they're seeing across their portfolios. So what were the findings here?
Dave Puchowski: Right. I mean overall separate from the survey, everyone has told us that portfolio health remains strong. Now, no one expects to go through a down cycle and not have some increased stress there, and that's happening. But the economy has held up well. You know there's some recessionary sectors like office real estate where too much exposure could be a problem. But overall, there's not huge amounts of concern here, so just wanted to preface with that.
But you know, with regard to the survey question and where the stress points are showing up.
Uh, I mentioned earlier the concerns around prolonged higher rates and and that came up in here as well you know covering higher interest costs or over a longer period of time is definitely a concern. But the one that got mentioned the most was slower growth and that also plays into the duration of this cycle. And if it is prolonged, how that impact will be felt and that aligns with you know, if we go back to your last question, some folks in the market being less bullish about how the rate cuts will go and and you know then you'd have prolonged cycle and the issues that could arise from that. So of course, there's always another half to it. And if companies can't solve the organic growth problem, and there's always the inorganic way through M&A, so maybe we start to see sellers capitulate on valuations more if this type of scenario were to play out. So will be interesting to follow, you know, with with these survey questions, we always get a nice mix of glass, half full and glass half empty responses. And the answer? The answer is usually somewhere in between.
CJ Doherty: And with that, we will wrap up for today. Thanks for joining me, Dave, and providing some really good stats and outlook on a relatively opaque market.
Dave Puchowski: Thanks for having me, CJ.
CJ Doherty: And thank you all for tuning in. I invite you to check out our direct lending news reports and analysis at loanconnector.com and follow us on X at LPC loans. I'm CJ Doherty, subscribe to the Lending Lowdown on your favorite podcast platform.
