(Bloomberg) – Fierce competition in the booming $1 trillion private credit market has seen debt levels soar in 2021, another sign of riskier lending as the struggle to win business s intensifies.
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According to investment bank Lincoln International, the number of midsize U.S. companies that took on debt at or above an average of seven times their earnings last year hit an all-time high, jumping 89% from 2020. Higher leverage has been more prevalent in the tech sector for some time, but it’s also creeping into others, like healthcare, as lenders try to find an edge.
“For the longest time, the leverage cap has never seen anything above 7x. The increase is transformative for the private credit market,” said Ron Kahn, CEO of Lincoln, based in Chicago, in an interview with Bloomberg.
One driver is the huge sums of money pouring into direct lending funds which put more pressure on lenders to deploy liquidity. This demand has swelled in part because private credit has fared better during the pandemic than some people expected, and also because there is more desire for variable rate debt in a rising equity environment. rate.
Private lenders, of course, have generally provided loans to middle-market companies that might not have been able to borrow from banks initially, just because, say, they are expanding and burning the money. Loans made by Wall Street and then syndicated to institutional investors were once considered problematic by regulators if the leverage was around six times or more, which attracted more attention.
Even so, the high leverage in direct lending was mostly reserved for sought-after tech companies for two main reasons: they have a high growth profile and a large portion of their revenue is recurring. To that end, Lincoln saw a 62% increase in technology deals underwritten for recurring revenue last year, compared to the prior year.
Read more: PRIVATE CREDIT WRAP: Leverage increases on software offerings
The rise in leverage across more sectors, however, reflects the recovery seen by many middle-market companies after a turbulent 2020. Business values rose 3.9% in the fourth quarter, driven by average revenue growth of 5.5% and Ebitda, according to Lincoln.
An increase in M&A activity in the fourth quarter also led to pent-up demand for loans from private equity firms. Higher purchase price multiples – which increased an average of 12 times a measure of earnings in 2021 from 10.4 times in 2019 – have also increased the need to borrow more.
In another change from the early days of the pandemic, when lenders cut lending, they are now investing more heavily in individual transactions – a move that raises concerns about concentration.
The average holdback size, or the share of a loan split among a group of lenders, reached $119.8 million last year, a 62.3% increase from the average of 79.7 million in 2020, according to Lincoln. Last year’s average exceeded the pre-pandemic level of $97.8 million, where, say, a loan of about $400 million was split into four.
“By placing more capital in a single transaction, it helps private credit companies deploy capital. However, it’s a bit of a concern because it’s also more exposure to a single credit,” Kahn said.
Lincoln’s findings are based on an analysis of 600 companies with less than $100 million in annual revenue.
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