Middle Market Divergence Ahead

Middle Market Divergence Ahead

Posted on Dec 13th, 2017

Looking Back:
Institutional lenders have been adding money supply to the credit market, reducing interest rates on Middle Market loans
Looking Around:
The Upper Middle Market is benefitting the most from this borrower-friendly market.
Looking Forward:
The lower Middle Market may expect debt pricing to increase.

Capital continues to flow into institutional leveraged loan funds, with a 9.0% increase in supply to the credit market year-over year. (Figure 1).

This surge has led to a yield that has been falling since late 2015 (Figure 2) and has created competitive pressure for traditional senior banks, forcing them to relax their internal loan application standards (Figure 3).

The effects of strong institutional lending activities and loosening senior bank standards are apparent in the Middle Market.  Lenders have become more tolerant of leverage ratios in order to win business (Figure 4).  Falling interest rates and increased Debt-to-EBITDA trends have created a friendly credit market for borrowers.

While this market seems great for the Middle Market borrower as a group, we know from our last publication that the size of the business really matters here.
When we dissect the Middle Market into categories by size, only the upper segment of the Middle Market has seen an increase in deal counts in 2017, while the bottom two segments show a significant decline (Figure 5). Large companies with a higher EBITDA are preferred by lenders and are enjoying this higher leverage ratio lending appetite. (Figure 6).

It is our opinion that the increase in supply to the credit market will continue because of interest rate expectations.  We expect the soft lending environment of the lower Middle Market to continue.  As a result, interest rates are likely to rise for these borrowers.