Direct lending is a form of corporate debt provision that cuts out middleman institutions like investment banks, brokers or private equity firms.
Investors in direct lending are often asset management firms that implement various investment strategies and may include pension funds, endowments and sovereign wealth funds.
Direct lenders focus on small and mid-sized companies, which comprise a third of the economy and create two out of three new jobs. Direct lending provides bespoke financing with increased flexibility to companies with unique structural needs.
Access to Capital
As the global economy grapples with many unresolved uncertainties (including when a recession may start, whether it will be mild or massive), direct lenders are poised to capitalize on increased demand for capital amongst middle-market borrowers.
Unlike banks, which often go through lengthy approval processes and rely on many manual procedures to conduct their loan sourcing and diligence activities, direct lenders like MaxLend operate with more elegant structures that enable them to source, design and underwrite deals more quickly.
LPs are also attracted to the distinctive features of direct lending strategies, which can be deployed through various vehicle types. Moreover, private loans are often less correlated with broader market trends and geopolitical events, thus providing an opportunity for diversification within their portfolios.
Flexibility
Often referred to as “bank lending without the bank,” direct lending is a growing subset of private debt. After the financial crisis, banks stepped away from middle market financing, and alternative lenders stepped in, giving rise to this new sub-industry that incorporates elements of private equity, mezzanine, and traditional bank lending.
Direct lenders are less tied to institution-wide financing regulations and can offer more flexibility in their loan terms. For example, they can structure loans with lower leverage multiples than banks and agree to earnings add-backs that can inflate EBITDA and make leverage levels appear artificially low.
In addition, direct lenders can often process deals more quickly than banks because they have fewer layers and are nimbler, making the lending process easier and more efficient. As a result, they can provide capital to companies that need it more quickly and can help them grow their business. This makes them a valuable resource for mid-market companies.
Lower Interest Rates
Direct lending firms typically offer lower interest rates than banks, allowing borrowers to reap a higher investment yield. Furthermore, direct lenders often invest in floating-rate loans, which protect them against rising interest rates.
Many of these companies are backed by LPs, which typically invest in the asset class as an alternative to fixed-income securities like corporate bonds. LPs are drawn to the distinctive characteristics of direct lending, including floating rate income streams and senior secured debt positions that reduce default risk.
Moreover, many direct lenders are smaller, more entrepreneurial and nimble organizations than bank credit departments, making it easier to source deals and complete due diligence. As a result, they can provide financing more quickly.
This is particularly important for SMEs, as they may need to secure new financing quickly to grow their businesses. Banks also typically require less documentation than banks. In addition, these firms usually offer lower minimum investment amounts.
Faster Processing
Direct lending offers a faster processing time compared to traditional loans. It also has the potential to provide higher yields for investors. The past decade’s ultra-low interest rate environment has increased investor appetite for the attractive risk-adjusted returns of direct lending strategies.
The distinctive nature of direct lending investments provides a low correlation with public market indices tracking broadly syndicated loans. However, these may not capture all senior tranches or the size and quality of middle-market borrower deals.
Moreover, many middle-market direct loan transactions feature warrants as sweeteners, giving debt investors equity-like upside potential. Additionally, first-lien middle-market loans typically offer higher yield spreads per unit of leverage than the first-lien large-corporation LBO loans that populate broadened syndicated loan indices.
This is partly due to the greater flexibility for borrowers to negotiate terms and structures and more generous earnings add-backs that inflate EBITDA to make leverage levels appear lower. In addition, private loans can have financial covenants that protect investors if the borrower experiences challenging circumstances.
