The Ongoing Evolution of Direct Lending TheOngoingEvolutionofDirectLending

As demand for non-bank capital increases and yields remain high on a historical basis, direct lending continues to grow as an asset class. While the conditions for growth last year were far from ideal – with central banks continuing to tighten monetary policy for much of 2023 and rising financing costs across the marketplace – direct lending continued to gain market share and remained resilient.¹

That resiliency was primarily driven by direct lending’s natural protection against inflation through floating rate loans. The increases in central bank rates have translated into higher yields, and risk premiums also remained at historically wide levels. ²

While the high-interest-rate environment has resulted in improved returns, allocators may wonder about its impact on borrower cash flows and their ability to service debt. PGIM Private Capital’s (PPC) fundamental approach to underwriting credit on a cash-flow basis – focusing on a company’s ability to service debt while also covering its fixed expenses – is key to navigating the credit cycle.

 

Focusing on the middle market 

In recent years, the direct lending market has seen increasing segmentation as it continues to mature. PPC focuses on the core middle market, companies with EBITDA of between $20 million and $50 million. 

“We believe the core middle market offers opportunity, in light of the fact that many larger direct lenders have moved to pursue larger company financings, which brings them into competition with providers of syndicated loans,” said Matthew Harvey, Head and Partner of PGIM Private Capital’s Alternatives Direct Lending Group. “At PGIM Private Capital, we finance companies that are owned by private-equity sponsors as well as family- or management-owned businesses that are looking to expand, recapitalize or make acquisitions.” 

PPC’s international network of 15 offices organized into nearly 50 deal teams, comprised of more than 200 investment professionals, supports building well-established relationships with companies and private-equity sponsors in their local markets.

“Our global origination capability allows us to work with a diversified pool of borrowers from both a sector and geographical perspective,” Harvey said. “We focus on the more conservative end of the market. Specifically, we work with companies that have leverage of no more than four times EBITDA, with a typical loan-to-enterprise value of 40%. We believe these parameters are specifically important throughout during periods of economic stress.”

PPC continues to expand in the core US market, as well as in Europe, Australia and New Zealand, and Latin America. The increasing liberalization of the direct lending market outside the US has played a key role, with PPC closing inaugural financing for issuers and sponsors in countries such as the Netherlands.

 

Looking ahead 

2023 was a record year for PGIM Private Capital’s direct lending business. Despite the challenging environment for M&A and leveraged-loan activity, PPC’s direct lending team generated new direct-loan originations worth nearly $2 billion across 50 transactions. Looking forward, as the macroeconomic backdrop continues to stabilize, this will likely lead to a resumption of M&A activity as well as general capital investment.

PGIM Private Capital’s ability to position itself as a first-lien senior secured investor, it’s emphasis on cash-flow coverage in the underwriting process, and multi-decade experience are key factors as the direct lending space continues to evolve.