Demand for "alternative" financial metrics is spurring interest in private credit at the expense of syndicated loans, according to research Wells Fargo published today.
An example is a loan based on a borrower's recurring revenue, as opposed to EBITDA.
"Aiding private credit in its ability to compete with syndicated markets is that it need not comply with the same regulatory regime as the banking industry. EBITDA adjustments can be too complex or stretched for rating agencies' comfort level, which is inhibitive to a syndicated solution," Wells Fargo analyst Finian O'Shea said in the research note.
"So it is not surprising that we see private credit trending toward alternative financial metrics, including recurring revenue, which has yet to make it into syndicated channels."
Wells Fargo cited the example of a $1 billion term loan to Pluralsight in the recent quarter. The debt features covenants based on recurring revenue through December 2023, switching to EBITDA-based covenants thereafter. Interest on the loan was L+800, with a 1% floor, "resulting in a 9% coupon in a market where bread-and-butter unitranche financings offered L+550 to 600," Wells Fargo said.
The research showed the breakdown of the Pluralsight loan, citing company reports.
"We believe the structure of the loan tells the story and flexes the advantages of private credit. We note the loan may well be a 'placeholder' to get Pluralsight to the syndicated markets (or at least a wider-reaching or lightly-syndicated club market), as it carries recurring revenue-based credit metrics until the end of 2023, when total leverage covenants flip to 6.75x to 7.25x EBITDA," O'Shea said. "Put another way, the loan allows for more flexible leverage covenants based on recurring revenue for roughly 3 years, after which Pluralsight is required to start checking the boxes of ordinary financings ~3 years before the loan's final maturity. When viewed through this lens, we don't see it as particularly excessive in its leniency."
Citing public company reports, the research showed the breakdown of the Pluralsight loan by lender. The leading lender was Owl Rock Capital Corp. with a $220 million holding as of December 2020, followed by Ares ($137.5 million), then Canyon, Golub, Goldman Sachs Asset Management and Oaktree ($110 million each). Benefit Street and BlackRock each held $82.5 million.
Recurring revenue loans are becoming more widely accepted as collateral, Wells Fargo said.
"For example, Golub Capital BDC's senior credit facility allows for advance rates as high as 75% to 85% for unquoted and quoted 'late-stage loans,' which are, in essence, recurring revenue loans by a different name," Wells Fargo said. "Likewise, Owl Rock Technology Finance has issued a middle market CLO that allows for up to 40% of collateral value to be invested in recurring revenue loans, subject to other limits governing concentration and credit risk."
If these types of loans become more widely accepted within credit, spreads are likely to compress, Wells Fargo noted.
"All this is to say that while we're likely still a long way from seeing these loans pass the sniff test for ratings agencies (a requirement for a true syndicated solution), they're certainly starting to get reception among the lenders who provide BDCs and private credit with the capital to get them done."