Through the second half of 2022, the average hold size decreased across almost all lenders.  Previously, a $400M financing would have required a 1-2 member club.  At current, that same financing likely requires 4-6 lenders, which significantly complicates the process of sourcing financing.  Designing financing processes to ensure maximum optionality and competitive tension requires increased management in the context of a 4-6 member club deal to ensure that options don’t “collapse” into each other too early in the process.  We also expect that documentation will be more difficult in this context as each lender will require some level of review / input. Furthermore—and perhaps in reaction to the aforementioned phenomenon—we envision an increasing number of all-cash transactions.

As this report noted in previous quarters, unitranche loans have been the favored structure within middle market sponsored finance for several years. Competitive rates, ease and surety of execution, and documentation flexibility provided by unitranche deals attracted sponsors to the structure as compared to split lien or senior / junior financing solutions. With the relative advantage of unitranche diminishing, Configure anticipates senior / junior structures to come back en vogue. Rising SOFR / LIBOR has led most loans to increase by more than 3.0%. Further, average spreads have widened to price in economic risk. The combination results in even top-quality unitranche loans pricing at an all-in rate well exceeding 10%. Although junior loan pricing generally exceeds that of unitranche loans, 2.0 – 5.0% lower spread on the senior debt provides significant debt service relief. Additionally, the All-In Rate on junior capital has not moved in lockstep with unitranche loans through the 2H 2022 period of restrictive monetary policy from the fed, which has led to benefits from a rate perspective for the structure. The flip side of proliferating senior / junior deals (and the pursuit thereof) is commercial bank skittishness and possible elevated amortization.

The post-COVID confluence of labor issues, supply chain disruption, inflation, and recession-driven revenue softening has been tremendously disruptive.  An increasing number of Configure’s engagements involve assisting in an amendment or waiver of some sort, often within the construct of bridging to a refinancing.  In exchange for sponsor support (incremental capital), lenders are being asked to revise covenant packages to allow the Company to recover to the point of a refinancing in the next 12-18 months.  The “market” level of relief is difficult to assess, as each of these situations are relatively unique and, as such, sponsors are keenly focused on how much relief should be expected in exchange for the incremental capital support.

Abundant capital allocated by eager dealmakers supported record M&A – and around the cycle went. The music hasn’t stopped, but internal credit professionals are singing in different keys. Committee members and originators have long approached the market with a similar mindset and the harmony benefited sponsors via trustworthy reads, IOIs, commitments, etc. Ample dry powder remains but questions surrounding how to deploy it abound. In addition to overcoming a greater percentage of declined deals, originators / underwriters will chase a moving target on commitment level, leverage, rate, and other terms. As a result, the process of managing debt placement becomes more involved and uncertain, particularly for larger private deals. Configure does not anticipate the disconnect to subside until there is clarity with regards to the economic outlook and depths of a potential recession.

The fraud and fallout caused by FTX’s collapse will undoubtedly generate a must-watch Netflix docuseries. More chips will fall and Configure expects one (or more) bankruptcy filings to be far more impactful to the middle market sponsor universe–although unlikely to match the theater provided by SBF & Co.