Direct lending constitutes the provision of credit directly (i.e., without an intermediary) to middle-market companies, mainly for the purpose of financing growth or acquisitions. This type of financing solution is considered to be an “alternative” financing technique as direct lenders, such as (debt) funds, stand outside the banking institutions that traditionally offer loans to companies.
Over the last few years, direct lending has picked up quite some momentum, thereby emerging as a viable alternative and addition to bank lending. We expect the direct lending market to further grow in the coming years, also in Belgium.
The growth of private credit is partially the result of the declining presence of traditional banks in Mid-Cap lending. Prior to the 2009 financial crisis, providing (senior) loans to middle-market companies had been almost the exclusive domain of commercial banks.
However, as a result of the financial crisis, the European banking sector underwent fundamental changes, including nationalisation, consolidation and bankruptcy. This led to a decrease in the number of banks active in the Mid-Cap loan market.
Moreover, traditional banks have been significantly constrained in their lending capabilities as the Basel regulations have forced them to comply with onerous capital requirements, which has led them to (i) increase their capital and comply with reserve requirements, (ii) scale down loan origination (specifically in certain “difficult” sectors), (iii) push back on leveraged loans, and (iv) reduce their loan books.
As a result, certain Mid-Caps have struggled to obtain suitable financing from the traditional banks. This is where private / direct lenders have come in to fill the funding gap.
Who, what, how?
Many direct lenders are funds which have comparable features to those seen in the private equity sector, i.e., a finite life of 10 years with a 3-5 / 5-7 year investment period.
These debt funds are often backed by institutional investors, such as insurance companies and asset managers, that have been drawn to the private debt market given the current excess liquidity in the public markets.
As a result, these investors have over the years developed a deeper understanding of the asset class, leading them to increasingly view private debt as a strategic portfolio allocation.
Features and key differences to bank lending
No amortisation / bullet repayment
Private debt lenders provide borrowers with access to non-amortising, bullet structures, whereas banks are keen to reduce their exposure vis-à-vis the borrower through amortisation of the loan. Bullet structures reduce the debt service of the borrower which leads to more cash in the business.
Direct lenders are willing to provide borrowers with an increased level of structural flexibility (headroom on covenants, increased leverage, dividend distributions, etc.), thereby offering a tailor-made financing solution. However, direct lenders will be seeking a higher yield in return for the flexibility and creativity provided.
Financing across the capital structure
Direct lenders are able to offer financing solutions across the capital structure of the borrower.
Generally, there are 3 categories of private debt:
- Senior loans: first lien loans secured by a (first ranking) security package, which serve as an alternative to bank financing. However, as mentioned above, direct lenders will be able to grant a tailor-made / flexible financing solution.
- Junior loans: subordinated loans (mezzanine and second lien) which rank behind the senior loan(s) in priority. Junior lenders will be looking for a higher reward given the higher risk assumed.
- Unitranche financing: a financing solution provided via a single debt facility / tranche. Such loans combine elements of both senior and junior debt, but are first lien in priority as generally no debt tranche is in front of them.
Exceptions do however exist whereby the RCF and Capex facilities are being provided by the banks (“super senior lenders”) and the unitranche by the debt fund(s), in which case an (LMA based) intercreditor agreement will be entered into for the purpose of setting out, among other things, the ranking of each creditor’s claims according to a payment waterfall
Private debt lenders (i) often mimic coupon features as sometimes seen in mezzanine transactions, such as PIK payments, as well as warrants or other equity-linked structures, (ii) do not or in a rather limited way syndicate the loans, leading them to take on bigger participations, (iii) request call protections against early repayments, and (iv) have shorter credit committee processes, allowing a higher speed of deal execution.
Direct lending in Belgium
Offering private debt to Belgian corporates does not qualify as such as a banking activity or any other regulated activity. No license, registration or filing is required.
Moreover, Belgian law is characterised by the “freedom to contract” principle and only features a limited number of mandatory provisions (e.g., interest on interest, early repayment penalties, SME law, etc.) which could potentially limit such freedom.
In addition, the Belgian legal framework applicable to (direct) lending activities (including the creation, perfection and enforcement of security interests) is straightforward and user-friendly, which makes Belgium a favourable jurisdiction to financing transactions.
To conclude, private debt is from a Belgian law perspective ideally placed to offer tailor-made financing solutions to corporate borrowers across every industry or sector.