In our 2022 Capital Markets Outlook, we discussed expectations for the year ahead. Topics included covenant-lite loans, inflation and rising interest rates, the LIBOR/SOFR transition, the heightened prevalence of unitranche loans and the continued focus on ESG.

Kelli Marti, Churchill’s head of CLO management, and Jessica Nels, capital markets, begin a series of market commentaries on the Outlook:

Historically, covenant-lite was not a topic for much conversation in the middle market, as these loans were seen mostly in the broadly syndicated market. As the market evolved competition intensified and lines blurred between public and private credit. Cov-lite increasingly gained share among smaller, unrated loans. What prompted this change? We observed:

• Larger sponsors eager to put capital to work are coming down-market and demanding large market terms from their club lenders;
• Increased competition among lenders resulting in willingness to differentiate with looser terms;
• Middle market borrowers using large DDTLs to grow through acquisitions, propelling those borrowers into a lender spectrum more willing to provide cov-lite solutions;
• Increase in direct lender capacity leading to smaller lender groups, all members required to accept issuer-friendly terms such as cov-lite;
• Proliferation of the unitranche, with mega-tranches stealing share from the syndicated market; and thus adopting or bridging the gap on their terms.