Key Takeaways

• Insights into the adaptation of direct lenders to potentially higher default rates encompass two key aspects: the hiring of restructuring professionals and the adjustment of loan terms and structures. These measures highlight how direct lenders are proactively managing their loans in response to the increased likelihood of defaults.

• Asos, a struggling online retailer, is considering hiring a restructuring expert, reflecting the practice of direct lenders hiring professionals to manage distressed loans. The appointment would aim to revive its performance, negotiate with borrowers regarding its expiring revolving credit facility (worth £350 million), and maximize recovery value in case of default.
• Some direct lenders may also offer more flexible or customized loan solutions, such as unitranche debt, which combines senior and junior debt into one instrument with a blended interest rate. For example, according to S&P Global, "some lenders championing "unitranche" structures that eliminate the complex capital structure of first- and second-lien debt in favor of a single facility. "

Introduction

Hiring Restructuring Professionals

• Direct lenders are hiring restructuring professionals to negotiate with borrowers, assess their financial situation, provide operational support, and maximize recovery value in case of default.
• Asos, a struggling online retailer, is considering hiring a restructuring expert, reflecting the practice of direct lenders hiring professionals to manage distressed loans. The appointment would aim to revive its performance, negotiate with borrowers regarding its expiring revolving credit facility (worth £350 million), and maximize recovery value in case of default.
• In 2021, China Evergrande, the troubled property developer, hired restructuring experts from Houlihan Lokey and Admiralty Harbour Capital to help it deal with its debt crisis. The company warned of severe financial pressure and said it had hired the advisers to "assess the group's capital structure."
• 
  
• Some direct lenders have established restructuring services through agents who provide operational support, leading to improved performance, enhanced shareholder value, and rapid changes in areas such as cash, working capital, and profitability. For example, Deloitte Operational Restructuring Services agents offer advice to corporate buyers and private equity investors on optimizing operational efficiency, which in turn improves performance and drives shareholder value.
• In addition, McKinsey’s RTS team works with companies to stabilize performance and liquidity, conduct a thorough situational and financial analysis, assess the turnaround options, prepare a robust plan, and execute the plan.
• Direct lenders are increasingly recognizing the need to have restructuring expertise in-house, especially in the private credit industry, to effectively manage distressed loans and navigate potential economic downturns. The hiring of restructuring professionals allows them to proactively address financial challenges faced by borrowers, negotiate with creditors, and maximize recovery value in case of default.
• The demand for experienced buy-side restructuring professionals is expected to rise sharply in the coming years, leading to a talent war and increased competition for these specialized individuals. Direct lenders are looking to staff up their restructuring teams, realizing the importance of having professionals who can navigate the complexities of restructuring and workout situations, particularly as lending standards have weakened and more "sloppy" deals require restructuring.

Adjusting Loan Terms and Structures

• Some direct lenders may tighten their covenants or collateral requirements to protect their downside and ensure compliance. For example, according to Aon, direct lending funds usually have strong covenants that are tested at regular intervals throughout the life of the loan, such as keeping the ratio of debt to EBITDA below a specific level.
• Some direct lenders may also offer more flexible or customized loan solutions, such as unitranche debt, which combines senior and junior debt into one instrument with a blended interest rate. For example, according to S&P Global, "some lenders championing "unitranche" structures that eliminate the complex capital structure of first- and second-lien debt in favor of a single facility. "
• Recent reports from Reuters indicate a significant increase in unitranche transaction volume. In 2021 alone, mid-market companies in the United States received $181 billion in unitranche loans, marking an 85% surge compared to 2020.
• Some direct lenders may increase their interest rates, fees, or equity stakes to compensate for the higher probability of default. For example, fees for private partnerships average 3.14% of net assets, up from 3.00% last year. The increase in fees comes from new higher-fee partnership offerings.
• In addition, the 3.14% average rate for fees equals 26% of the 12.01% average gross-of-fee portfolio return assumption, including leverage, up from 24% one year ago. This indicates that fees account for a significant portion of the expected returns.

Research Strategy