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What’s Market: 2023 Year-End Trends in Large Cap and Middle Market Loans

Maria Barclay, Timothy A Fanning, Ikhlas Sabreen Rashid, Cassandra G Mott, and Sanders Witkow

What’s Market: 2023 Year-End Trends in Large Cap and Middle Market Loans

Overview/Market Analysis

The US loan market had a choppy year in 2023, with regional bank failures in the spring adding to an uncertain economic picture, as businesses confronted the steepest interest rate hikes in over 40 years, and some struggled to adapt. The unwinding of the remaining pandemic-related imbalances of supply and demand in various sectors of the economy provided encouraging news for inflation, but the Federal Reserve (the Fed) continued to talk tough on monetary policy, expressing concerns about stubborn core inflation driving the need to maintain restrictive monetary policy. The nearing US election cycle and legion geopolitical concerns informed loan market sentiment, which saw reduced risk tolerance from lenders and greater focus on credit quality.

Behind the headline numbers, the market saw something of a division, with highly competitive refinancings and acquisition financings at one end of the market, while liquidity-strapped companies and distressed borrowers experienced a far tighter credit environment. Retrenchment from the credit markets by regional banks in particular, in the wake of the bank collapses, continued to provide a market opening to direct lenders. Private credit continued to exhibit a healthy performance, including taking deal sizes up-market into territory usually considered the domain of the broadly syndicated loan (BSL) market.

Total US syndicated lending stood at $2.4 trillion in 2023, a decrease of 19% compared to 2022, according to LSEG Global Syndicated Loan Review, though deal activity levels started to pick up in the fourth quarter of 2023.

The largest group of investors in the leveraged loan market, collateralized loan obligations (CLOs), were also affected by difficult economic conditions, with new issue activity falling from $128.9 billion in 2022 to $115.6 billion in 2023, a drop of over 10%. Issuances of BSL CLOs, which pool together syndicated loans, cooled to $88.9 billion, a drop of 23%. However, middle market/private credit CLO issuance more than doubled to a record $26.7 billion. Depressed activity in the overall CLO market resulted in less liquidity in the primary and secondary market, leading to weaker leveraged loan performance.

Leveraged loan issuance declined to $737 billion in 2023, dropping 13% year-over-year. Institutional lending reached $311 billion, an 8% increase. Pro-rata lending levels, in contrast, fell 23% to $451 billion.

Annual Leveraged Loan Issuance ($B)

Annual Leveraged Loan Issuance ($B)

Higher debt costs, a weaker mergers and acquisitions (M&A) pipeline, and tighter credit conditions resulted in opportunistic transactions, such as refinancings, repricings, amend & extend (A&E) transactions, and dividend recapitalizations (dividend recaps), dominating the loan market throughout 2023. Continuing the momentum from the first half of 2023, institutional refinancing transactions surged 141% over the prior year's levels to finish the year at $206 billion.

In this tightened credit environment, A&E activity continued to perform strongly, as borrowers found these transactions more attractive than a full refinancing. Under a new loan deal, a borrower may have to present new information about its business, go through a full syndication, and negotiate and close under new transaction documents, while an A&E typically maintains the status quo. According to Pitchbook, A&E levels spiked to $175.9 billion in 2023, an increase of more than $65 billion over the previous record of $110.1 billion set in 2021.

Borrowers remained focused on managing their debt maturities. According to data from MUFG Securities Americas Inc., approximately $329 billion of leveraged loans will mature over the next two years. As borrowers continue to chip away at this looming debt maturity wall, market observers anticipate a healthy flow of A&E and refinancing transactions to continue.

Although dividend recap volume was muted in 2022, after the Fed started aggressively raising interest rates, the market saw something of a revival in 2023. According to a Wall Street Journal article, dividend recap issuance jumped 71% in the first eight months of 2023 compared to the same period in 2022.

New money institutional loan issuance, including M&A, remained sluggish in 2023, with institutional new money issuance dropping 47% to $106 billion.

With a lack of alignment between buyers and sellers over valuations, higher interest rates and economic uncertainty, syndicated leveraged-loan buyouts (LBOs) dropped to $39.4 billion in 2023, a 65% decline from the prior year and the lowest since 2009. Direct lending LBO transactions also decreased, falling 38% from the prior year. However, direct lending LBOs comprised 59% of overall LBO loan volume, demonstrating that despite an overall slowdown, direct lending continued to play a significant role in acquisition financing.

Syndicated middle market lending fell to its lowest quarterly level in the fourth quarter of 2023, dropping to $24.6 billion, a 16% drop from volume in the third quarter.

Although the market continued to lean more lender-friendly in 2023, covenant-lite (cov-lite) loans continued to dominate. According to Pitchbook|LCD, approximately 90% of the outstanding US leveraged loans (at par) were cov-lite, consistent with 2022 levels. Although historically a part of BSL transactions, there has recently also been an increase in cov-lite loans in the direct lending market. Direct lenders have become more flexible, accepting less stringent financial covenant packages and pricing in their facilities as the direct lending space continues to grow. For more information on cov-lite loans, see Practice Note, Covenant-Lite Loans: Overview.

Direct lending continued to perform well in 2023. According to KBRA Direct Lending Deals (KBRA DLD), direct lending ended the year with an impressive market size of $1.4 trillion, roughly the same size as the leveraged loan market.

Refinancings represented 26% of direct lending activity, a sizeable jump from 7% in 2022, according to KBRA DLD. Jumbo refinancings (loans of $1 billion or more) accounted for about half of jumbo loan direct lending activity and helped to solidify private credit as a key competitor to the BSL market. As loan parties continued to look for opportunities outside the BSL market, several noteworthy corporate borrowers refinanced their syndicated loans with direct loans, as seen in:

  • The $3.4 billion unitranche loan for Hyland Software, Inc., which refinanced its existing syndicated facility and consisted of a first lien loan, second lien loan, and revolving facility. The new unitranche facility includes a $3.25 billion term loan and a $150 million revolving facility.
  • The $5.3 billion facility for Finastra Group Holdings Ltd., which included a $4.8 billion unitranche term loan and $500 million revolving facility to refinance its existing syndicated debt.

In what some market participants call the "flight to quality," total leverage levels remained low in 2023 as the market continued to favor the strongest borrowers. For large corporate LBO deals, average total leverage dropped to 5.9x in 2023, down from 7.1x in 2022, and the average equity contribution increased to the highest level recorded, 52% in 2023, up from 45% in 2022. LBO deals with leverage 7x or higher declined to 9% in 2023, compared to 68% in 2022.

Higher interest rates continued to pile pressure on distressed borrowers, pushing the leveraged loan default rate from 1.6% in 2022 to 3.04% in 2023, according to Fitch Ratings. Loan default volumes reached $50.5 billion in 2023, the result of 67 separate issuers defaulting under their loan agreements. Fitch predicts a leveraged loan default rate of 3.5-4.0% in 2024, with greatest concern in the healthcare, telecom, and technology sectors.

Corporate bankruptcies skyrocketed in 2023, with 642 companies filing for bankruptcy protection, an increase of 72.5% from 2022 and more than in any of the last three years, according to S&P Global Market Intelligence.

As bankruptcy filings increased, so have debtor-in-possession (DIP) financings. The increase in activity observed in the first half of 2023 continued through the end of the year. To meet the needs of the market, DIP financing has continued to evolve regarding loan structure and the identity of DIP lenders. For more information on DIP financing trends, see Article, Key Developments and Trends in DIP Financing (2022/2023).

Several well-known companies have executed DIPs in 2023, including:

2023 also saw the first DIP financings solely denominated in cryptocurrency. In June 2023, the Delaware bankruptcy court approved the DIP financing for Bittrex, under which the debtor obtained post-petition financing exclusively in Bitcoin. According to market observers, although the case does not necessarily provide a helpful blueprint for other crypto companies pursuing bankruptcy, the filing may open the gate for other DIP financings in the form of cryptocurrencies.

This article examines topical developments seen in the US loan market in 2023, certain of which are further discussed in:

Loan Market Developments

Along with economic conditions, numerous judicial, legislative, and regulatory developments continued to shape the loan market in 2023.

Kirschner: Loans Are Not Securities

On August 24, 2023, the US Court of Appeals for the Second Circuit affirmed a decision of the United States District Court for the Southern District of New York holding that syndicated loans are not securities subject to the securities laws (Kirschner v. JPMorgan Chase Bank, 79 F.4th 290 (2d Cir. 2023); for case background, see Legal Update, Kirschner v. JPMorgan Chase Bank: Syndicated Loans Are Not Securities). This decision endorses the long-held view among many loan market practitioners that the securities laws do not apply to syndicated loans. For more information on the Second Circuit's decision, see Legal Update, Kirschner v. JPMorgan Chase Bank: Second Circuit Affirms that Syndicated Loans Are Not Securities.

Although Kirschner filed a petition for certiorari to the Supreme Court in January 2024, the Court denied the petition, leaving in place the Second Circuit's decision that syndicated loans are not securities. To the relief of loan market participants, this should finally lay to rest concerns that developments in the syndicated loan market may have pushed syndicated loans into the realm of securities regulation.

Corporate Transparency Act

On January 1, 2024, the Corporate Transparency Act (CTA) beneficial ownership information reporting rule (BOI Rule) issued by the US Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) became effective. The CTA is aimed at promoting financial transparency by establishing a national registry of beneficial owners of legal entities conducting business in the US, for the benefit of certain governmental agencies and entities and in some cases financial institutions, to facilitate their regulatory compliance obligations. The BOI Rule requires certain legal entities to file reports providing information about the entity, its beneficial owners, and, in some cases, its company applicants to FinCEN for recording in the registry.

It is too soon to assess the full implications of the BOI Rule on loan transactions. The final rulemaking implementing the CTA will make conforming changes to the beneficial ownership provisions of FinCEN's existing customer due diligence rule (CDD Rule). Market participants are considering now how the BOI Rule, and the CTA may affect loan procedures, opinions, due diligence, and credit agreement provisions.

For more information on the BOI Rule, the CTA, and its implications, see:

Panel LIBOR Cessation

Last year marked the end of an era as USD panel LIBOR was discontinued on June 30, 2023.

Although market participants have spent the past few years preparing for panel LIBOR's cessation, a large proportion of legacy loans in the loan market still referenced LIBOR at the beginning of 2023. As a result, there was a flurry of amendment activity in the early part of the year to close the gap before the June deadline. For many LIBOR-based credit agreements, the transition process involved amending the loan agreement with what became known as a LIBOR transition amendment.

The Secured Overnight Financing Rate (SOFR) emerged as the favorite replacement rate for USD LIBOR in the loan market. According to an LSTA report, 76% of the loans in the JPMorgan loan index referenced SOFR by the end of August 2023. In a move that further cemented SOFR's place as the leading replacement rate, Bloomberg Index Services Limited announced that BSBY, once considered a potential replacement rate for LIBOR, will cease publication on November 15, 2024.

As a result of lessons learned from LIBOR's cessation, SOFR-based credit agreements generally include a benchmark replacement mechanism in case the initial SOFR-based benchmark interest rate becomes unavailable or is no longer representative. Many SOFR-based loans also incorporate an appropriate credit spread adjustment to address the differential between SOFR and LIBOR.

For additional information on LIBOR transition and SOFR-based loans, see:

2022 UCC Amendments

In 2023, the market maintained a keen focus on technology and its use in secured transactions. In 2022, the Uniform Law Commission (ULC), together with the American Law Institute, approved amendments to the Uniform Commercial Code (UCC) to deal with emerging technology and the treatment of digital assets, such as virtual currency and non-fungible tokens (NFTs). The amendments include the addition of new UCC Article 12, which provides rules for transactions involving certain types of digital assets, defined as controllable electronic records (CERs). The 2022 UCC amendments also seek to clarify the treatment of digital assets as collateral in secured transactions. By doing so, the amendments help to support financing markets that leverage digital assets as collateral.

The 2022 UCC amendments are now being considered for adoption by the states. According to the enactment history page on the ULC website relating to the 2022 UCC amendments, as of February 29, 2024, 13 states have enacted these amendments (including California and Delaware), while 15 states have introduced the legislation (including New York). For more information on the 2022 amendments, see:

Sustainable Financing

After increasing for many years, the sustainable finance market was not immune to the macroeconomic conditions that weighed down the corporate loan market. Economic uncertainty coupled with growing political sentiment against environmental, social, and governance (ESG) policies and tighter requirements resulted last year in lower issuances of sustainability-linked loans (SLLs), one of the most popular sustainable finance products. According to LSEG, global SLL issuances dropped by 36% year-on-year as of November 2023.

Concerns that some borrowers may have been manipulating certain metrics to receive promised economic benefits or that loans being marketed as SLLs did not require borrowers to meet sustainability objectives prompted industry leaders to establish more stringent market standards. In February 2023, the LSTA, together with the Loan Market Association (LMA) and the Asia Pacific Loan Market Association (APLMA), published updated versions of the principles and guidance related to SLLs that clarified the conditions a loan must satisfy to be classified as an SLL, provided that loan agreements that did not include performance indicators and targets at closing could not be marketed as an SLL, and required loans to be declassified as an SLL under certain circumstances. For more information on SLLs, see Practice Notes, Understanding Sustainability-Linked Loans and What's Market: Sustainability-Linked Loans.

In response to these developments, some lenders have redesigned their SLL programs to provide more creditability to the market and reduce the risk of greenwashing. Lenders are also attempting to balance the need for tougher standards without affecting borrower demand for SLLs. Lenders are working closely with borrowers and sustainability advisors to craft metrics that meaningfully improve a borrower's sustainability profile and to require borrowers to produce data that support those metrics.

Ensuring the integrity of the SLL market is particularly important to lenders, because they often include sustainable finance products in calculating their own ESG commitments. Approaches used or under consideration by lenders include:

  • Adding declassification clauses to more SLL agreements. These clauses, which were recommended in the February 2023 update of the SLL principles, allow the lenders to remove the sustainability designation from a loan if its sustainability performance targets (SPTs) are no longer considered meaningful or ambitious enough.
  • Creating additional penalties in SLL agreements that raise the cost of borrowing if the borrower misses its SPTs.
  • Making the missing of a sustainability commitment a default under the loan agreement, which requires immediate repayment. These provisions reportedly appear in some private SLL deals.

Examples of clauses in SLL agreements aimed at curbing greenwashing include:

Despite a challenging political environment, sustainable financing remains important. While many companies and financial institutions are downplaying their sustainability achievements and goals (a phenomenon referred to as greenhushing) or avoiding the use of the term ESG to avoid accusations of greenwashing or the attention or scrutiny of politicians, many remain committed to sustainability principles. Banks reportedly are continuing to establish sustainability teams and to mobilize capital for clean energy and sustainability initiatives. As sustainable financing becomes more strategic, market participants are reframing it as a good investment that generates value rather than a value-driven product.

Bank Failures

The collective failures of Silicon Valley Bank (SVB), Signature Bank (Signature), and First Republic Bank in the early part of 2023 led to uncertainty and worry for market participants. To contain the damage and safeguard all deposits, the Federal Deposit Insurance Corporation (FDIC) issued systemic risk exceptions for SVB and Signature. The collapse of SVB was attributable to various factors, including the interest rate increases since 2022, particularly affecting the start-up sector. For lenders, these bank failures highlighted several concerns, including fears of a loss of confidence in the banking sector. In April 2023, the Federal Reserve Board (FRB) announced the results of its review of SVB's failure. The review included general recommendations to strengthen FRB's supervision and regulation going forward.

For more information about SVB's failure, see Legal Update, Silicon Valley Bank and its Aftermath. For information on how US banking agencies took action after these bank failures, see Legal Updates, US Banking Agencies Respond to the Collapse of Silicon Valley Bank and Signature Bank and Federal Reserve Board Announces Results of SVB Supervision and Regulation Review.

Alternative Financing Options

Funds, facing a constrained environment in 2023, encountered increased difficulty in fundraising and in securing financing, prompting them to explore alternatives like net asset value (NAV) financing. NAV financing involves securing a fund-level loan based on the net asset value of the fund's assets (rather than its uncalled capital). This type of financing enabled funds to address working capital liquidity needs, make new or follow-on asset-level investments, and provide capital returns to investors.

For more information on fund finance and NAV financing, see Practice Note, Fund Finance: Overview.

Simultaneously, private credit providers, recognizing the risks inherent in the lending landscape, diversified their offered financings to include options like recurring revenue loans (RRLs). RRLs are structured based on a company's recurring revenue rather than its profitability. The borrowers of these facilities are primarily growth stage companies, often in the technology sector, characterized by low or negative EBITDA. RRLs were a popular structure in 2023, for banks and other lenders, despite key terms such as the recurring revenue definition, conversion date mechanics and basket structures remaining in flux.

For more information on RRLs, see Article, Recurring Revenue Loans: Key Considerations for Market Participants.

Loan Negotiation and Documentation Trends

With higher interest rates and parties far apart on business valuations, acquisition financing was slow, but those deals coming to the market were highly competitive. M&A deals involving top-tier sponsors were among the most competitive, which kept terms borrower-favorable, even among direct lending deals. A heavy focus on creditworthiness meant that some middle market borrowers faced tight credit conditions. Private credit supplied some liquidity, but many direct lenders favor sectors that are less vulnerable in a downturn, leaving some companies, especially those in consumer-facing sectors, with fewer financing options.

Dividend recaps saw an uptick in 2023, as private equity firms sought to return some funds to their investors. The large unitranche deals of 2023 showed direct lenders increasingly competing in the large middle market and large cap space. Restructuring amendments were widespread, according to practitioners, as borrowers ran into liquidity problems or sought covenant relief, particularly in private deals where the resolution often involved additional sponsor equity as part of the negotiated relief.

As acquisition financings picked up in the fourth quarter of 2023, borrowers and lenders began to pay greater attention to the duration of financing commitment periods, and the associated economics of ticking fees. Practitioners report that concerns about anti-trust regulatory approval taking longer and a more assertive stance by the Federal Trade Commission in particular, have driven borrowers and sponsors to seek longer commitments for which lenders require compensation in the form of ticking fees, which are payable on the undrawn commitments.

Loan Terms

Negotiation of loan agreement terms continued to revolve around two main areas of focus in 2023. The first of these was leverage, ensuring that leverage levels were set appropriately and that the measurement of leverage ratios aligned with commercial realities. The second main area of focus was to ensure that assets and value were kept within the credit group and that borrowers should have limited ability under loan agreement covenants to free up assets to support additional financing.

The shifting negotiating leverage of parties in different sectors of the loan market saw borrowers and lenders achieving outcomes in loan negotiations that were either more or less favorable, depending on the borrower's creditworthiness and demand from lenders. In the large cap lending space and among competitive private credit deals, terms leaned towards being more borrower favorable. In a less competitive transaction environment more typical in middle market deals, there was a greater focus by lenders on preserving control over their collateral. Loan agreement provisions giving the borrower greater operational flexibility were more likely to be met with resistance by lenders.

Loan terms that featured more prominently for practitioners in loan negotiations in 2023 included provisions addressing:

  • EBITDA add-backs. In a continued shift away from the more accommodating approach taken by some lenders in recent times, the definition of EBITDA in loan agreements, as one of the building blocks of the leverage ratio, continues to come under scrutiny by lenders in loan negotiations. Greater attention is paid to the most speculative add-backs, including those that relate to extraordinary and unusual items of expenditure that the borrower wants to add back to its earnings for covenant purposes. Lenders took a more robust line in deal negotiations in 2023 and were less likely to agree to borrower requests for individual add-backs, and more likely to impose line-item caps and overall caps, often at lower levels than had become typical in recent years. In the large cap BSL market, caps in recent years were observed in the range of 20% to 25% of four-quarter EBITDA. In 2023, in contrast, market watchers reported seeing line-item caps, in large cap transactions, as low as 15% (What's Market, Hasbro, Inc. credit agreement summary (run-rate cost savings capped at 15%)). In the middle market, line-item caps as low as 10% (What's Market, Harmony Biosciences Holdings, Inc. credit agreement summary ("run-rate" cost savings capped at 10% of consolidated EBITDA)) and overall caps as low as 5% (What's Market, Portillo's Holdings LLC credit agreement summary) were observed.
  • Financial covenants. In an uncertain economic environment, borrowers' financial performance metrics were predictably an area of growing importance in loan negotiations in 2023, further fueled by the steep increases in interest rates. In the BSL market, covenant-lite deal structures continued to dominate and ratio levels were more accommodating. In most of the middle market space, practitioners generally observed tighter leverage ratios in loan agreements and saw an increase in the number of deals with multiple financial ratios, typically combinations of a leverage ratio and an interest coverage ratio, and sometimes a minimum liquidity requirement. Interest coverage ratios had fallen by the wayside in many BSL negotiations when interest rates were low, but with interest rates at current levels interest coverage ratios have more significance as measures of financial performance. For examples of middle market transactions with multiple financial ratios, see What's Market, Harmony Biosciences Holdings, Inc. credit agreement summary (financial covenants include maximum senior secured net leverage ratio, minimum consolidated interest coverage ratio, and minimum liquidity test), What's Market, Conn Appliances, Inc. loan agreement summary (financial covenants include minimum interest coverage ratio, maximum leverage ratio, minimum liquidity test, among others). Anecdotally, practitioners report seeing interest coverage tests in BSL and private credit loan covenant packages. For examples of large cap BSL transactions with financial covenants that include an interest coverage test, see What's Market, Hasbro. Inc. third amended and restated credit agreement (interest coverage ratio and leverage ratios) and What's Market, Host Hotels & Resorts, L.P. sixth amended and restated credit agreement summary (maximum leverage ratio, minimum unsecured interest coverage ratio, and minimum fixed charge coverage ratio).
  • Collateral support. Reduced risk tolerance among lenders prompted greater concerns by lenders about rights against collateral, and accessibility of collateral through landlord lien waivers and bailee consents. In prior years, many lenders were more relaxed about these items, which were frequently either left until after closing or not sought at all, but in loan negotiations in 2023 these were more likely to appear as closing conditions. Practitioners also reported that lenders increasingly paid more attention to obtaining collateral and guarantees from a borrower's foreign subsidiaries, where practicable to do so. The deemed dividend tax reform enacted under the Tax Cuts and Jobs Act at the end of 2017, made it easier for foreign subsidiaries to provide guarantees and collateral without creating negative tax consequences. There was little change in market practice in the immediate aftermath of the tax law changes, with most deals ignoring the new regime. There is now a greater focus in deals on the provision of collateral and guarantees by foreign subsidiaries, though the considerations weighed in the decision will ultimately be driven by the value of the collateral or credit support and the steps that are involved and the associated cost.
  • Additional debt and lender yield protection. Limiting the ability of borrowers to incur additional debt remained a priority in loan negotiations, with incremental debt permissions being more restrictive. Lenders had little appetite for allowing borrowers to take on significant amounts of additional debt. Instead, market volatility and uncertainty about interest rates led to greater focus on most-favored nation (MFN) pricing protections, with lenders undoing some of the borrower-favorable limitations and permissions, such as shorter sunset periods and MFN carveouts that had become common in recent years. Market participants observed call protection being extended to circumstances where the loan was accelerated by the lenders after a default. See What's Market, Kore Wireless Group Holdings, Inc. credit agreement summary.
  • Negative covenant baskets. In all but the strongest credits, negotiations of negative covenant baskets are generally seen as resulting in tighter covenants, particularly baskets for restricted payments and investments. In middle market deals, some lenders eliminated leveraged-based restricted payment permissions. There was a greater use of fixed baskets in negative covenants, trending away from builder and grower components.

    Leverage-based baskets, when retained, were generally seen as tighter in most deals. Concerns about steep interest rates have also motivated some lenders in BSL transactions and larger direct lending deals to tighten ratio baskets by adding an interest coverage test to ratio-based baskets. Lenders also tightened the ratio basket for restricted payments by replacing the first lien leverage test, the typical test for the restricted payments basket, with the total leverage test. For examples of credit agreements with a total leverage test for the restricted payments basket, see What's Market, ASGN Incorporated third amended and restated credit agreement summary and What's Market, Surgery Center Holdings, Inc. credit agreement summary.

    In some sponsored transactions, practitioners reported seeing leverage-based covenant exceptions retained to preserve concepts in precedent documentation but with covenant levels set so far inside of closing date leverage as to make the permission effectively redundant.

    Basket reallocation provisions were also less common in 2023 than in prior years, with tightened reallocation provisions across all negative covenant baskets. Practitioners note that one of the most borrower-favorable reallocations, using restricted payment capacity to bolster additional debt capacity, was eliminated in most deals.

    An additional point of negotiation in discussions about negative covenant restrictions in the direct lending space concerned the ability of borrowers to repay subordinated debt and debt secured by junior liens, with some direct lenders scrutinizing and tightening the permissions for restricted debt payments.
  • Capital structures. Flexibility around the borrower's capital structure remained an important point for many sponsors and featured prominently in many direct lending deals in 2023. Sponsors often want the ability to raise junior capital within the borrower's capital structure. Sponsored deals also involve a greater use of holdco debt, which in turn prompts borrowers to ensure that the loan agreement permits the borrower to transfer funds to the parent company to service the holdco debt. Concerns about the amount of interest payments that certain borrowers face and the impact on their liquidity has led to greater use of payment-in-kind (PIK) interest provisions in loan agreements, especially in direct lending deals. For examples of credit agreements with PIK interest provisions, see What's Market, Wheels Up Experience Inc. credit agreement summary and What's Market, Bright Health Group, Inc. credit agreement summary.
  • Liability Management Transactions. Consistent with lenders' concerns around negative covenant baskets in general, covenant exceptions leading to collateral leakage were a focus of loan negotiations. Greater control over the borrower's use of unrestricted subsidiaries ranked high among lenders' concerns and their ability to be primed by other creditors. Confronted with fast approaching maturity dates and an inability to access the loan markets some distressed borrowers continued to turn to liability management transactions as an alternative to bankruptcy.

    Mindful of permitting borrower to engage in drop-down transactions, lenders continued to take a stricter view about unrestricted subsidiary designation and the use of unrestricted subsidiaries to move assets out of the credit group. Transfers of assets to unrestricted subsidiaries and the ability of a borrower to make investments in unrestricted subsidiaries and non-guarantor subsidiaries were often regulated tightly, with smaller baskets and tighter leverage-based conditions becoming more common. Focusing on investments in unrestricted subsidiaries, some direct lenders further limit investments by restricting those investments to a dedicated unrestricted subsidiary basket. In these deals, investments using other baskets and reallocation to the unrestricted subsidiary basket are prohibited.

    Lenders in the BSL market often successfully negotiated for expanded "sacred rights" with the most protective provisions requiring the consent of "all affected lenders" for amendments that subordinate a lender's lien or right of payment to other debt (Serta protections).

    To prevent amendments that strip covenants and make other materially adverse changes, practitioners have observed lenders coupling Serta protections with revisions to the "Required Lender" definition, removing from its computation any loans subject to repurchase either through a non-ratable open market purchase or a Dutch Auction.

For more information on liability management transactions, including double-dip transactions, see Practice Note, Finance Fundamentals: Drop-Down Financings v. Uptiering Transactions in Liability Management Transactions.

Looking Forward

Although geopolitical issues, the upcoming US elections, uncertainty surrounding the Fed’s monetary policy, and other macroeconomic concerns are likely to stay top of mind throughout 2024, there is room for optimism. Although still elevated, interest rates have stabilized over the past few months, and investors seem to have become more comfortable with the current environment. Practitioners are hopeful that pent-up demand will stimulate the M&A market, and many expect to see a boost in acquisition activity as market participants look for opportunities to deploy capital amid lower borrowing costs. Refinancing and repricing transactions are also expected to remain strong, especially among the strongest credits, and the healthy flow of A&Es will likely continue.

Market watchers anticipate that direct lending will continue to grow. According to data from S&P Global, private credit funds had more than $400 billion in dry powder (as of September 2023), giving them plenty of liquidity to invest. Still, competition with the BSL market remains strong, and practitioners expect to see an uptick in bank deals in 2024.

As challenges persist in the market, credit quality will likely continue to be a key factor in loan negotiations, with the strongest borrowers being able to obtain the most favorable terms. Market participants will be keeping a close watch on default rates, which are expected to rise amid continued economic pressure. 

The market statistics cited in this article (unless otherwise stated) were provided by Refinitiv LPC, an LSEG business.