After the shock of the financial crisis, many investors and industry observers felt that the riskier end of the debt markets would be frozen out of play. Compelled by new regulations around capital controls, banks retreated from lending to all but the most secure of debtors, while investors were reluctant to dive into anything without a safe haven label.
Just as nature abhors a vacuum, so does the leveraged loans market. Yet into the gap left by the banks has stepped a range of new investors. And in other markets, more players are broadening the field, too.
Direct lending funds have sprung up all over Europe and the US to provide financing to the smallest SMEs up to the largest companies seeking loans over bonds. In the last few years, a range of fixed income managers have signed up with banks and other providers to seek a single layer of debt, forming a group of unitranche lenders. These lenders are now increasingly taking US$500 million transactions in their stride, whereas they had traditionally stuck with US$100 million deals or lower. Since 2007, these funds' assets under management grew from around US$200 billion to close to US$650 billion by the end of 2017, according to Preqin.
The renewed faith in CLOs also looks set to keep invigorating bank balance sheets as investors need yield, ensuring that the flow of capital continues apace.
Some forces at work could curb that capital flow. Restrictive European lending guidelines that some have decided to overlook may come back with a vengeance if household names—including some shaky-looking retailers—collapse, taking their leveraged debt providers with them.
And as investor confidence in direct lending has not been tested through the cycle, it would only take a couple of distressed situations in which a lender loses its investment to pour cold water on this lucrative—for the moment—practice.
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