Bombardier had always relied on its banks to raise large amounts of funding, but when the Canadian aircraft maker needed a $1bn loan at the height of the coronavirus crisis it turned elsewhere: to a private investment firm.

Medium-sized businesses have for years raised debt from so-called direct lenders, which often sit within larger private equity groups. But a rush of inflows from deep-pocketed investors such as Middle Eastern sovereign wealth funds is now giving some investment firms the firepower to lend to larger companies. The coronavirus crisis, which upended corporate balance sheets, has accelerated the shift, executives say.

Paulo Eapen, head of the European business at Blackstone’s GSO Capital Partners, said it was busier than ever. “We tend to be more active in periods of dislocation and I think we’ll be in a period of dislocation for a while.”

GSO is one of a handful of firms that can single-handedly write a $1bn cheque, a group that includes private equity firms — such as Apollo and Ares — and Bombardier’s lender HPS Investments, a specialist debt investor with $60bn in assets.

In a sign of how competition is hotting up for jumbo-sized deals, Apollo in July unveiled a new direct lending partnership with Abu Dhabi sovereign wealth fund Mubadala, which will expressly target $1bn deals, with the aim to deploy $12bn in just three years.

Mubadala also struck a similar but smaller partnership in September with asset manager Barings, targeting European companies. The investment arm of Credit Suisse, meanwhile, teamed up with the Qatar Investment Authority to launch what it called “a multibillion dollar direct private credit platform”.

Bar chart of Amount raised by direct lending funds ($bn) showing Money focused on direct lending is steadily growing

Large-scale loans are not new. Last year, Apollo backed the takeover of US newspaper business Gannett with a $1.8bn loan, at an eye-watering 11.5 per cent interest rate. 

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But James Zelter, Apollo’s co-president and chief investment officer of credit, said that such large-scale lending opportunities had “only accelerated” since the onset of the pandemic.

“There is a challenging credit environment coming up and our view is that those companies will need different capital solutions,” he told the Financial Times.

Many of the firms at the forefront of the direct lending boom can trace their lineage back to Michael Milken, the creator of the modern-day junk bond market. Apollo’s co-founder Leon Black was a senior executive at Mr Milken’s Drexel Burnham Lambert in the 1980s, as was his brother-in-law Tony Ressler, who also co-founded Ares in 1997.

Since the buccaneering era of the 1980s junk-bond boom and bust, however, the now relatively staid high-yield bond market has grown past $1tn in the US, as has its close cousin leveraged loans. In both, investment banks underwrite debt for companies on highly standardised terms, before distributing it to hundreds of asset management companies.

Direct lenders, by contrast, act alone or in a small club. They can offer loans with unconventional features, such as delayed drawdowns, in a process conducted entirely away from the glare of public markets. This greater privacy and flexibility comes at a cost, meaning that large deals tend to stem from private equity-backed companies with a specific reason for eschewing public markets. 

Ares broke records for the largest ever private-lending deal in June, arranging a £1.9bn loan package for Ardonagh, a privately owned UK insurance broker that previously received a mixed reception in the high-yield bond market. 

Bombardier, founded 78 years ago, has been listed for decades and has billions of dollars of publicly traded bonds outstanding. Yet as it looked to plug a potential funding gap this summer, while awaiting regulatory approval to sell its €7.5bn train division, the manufacturing giant turned to HPS instead.

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“We had to look at every element of their existing capital structure, all the various business divisions and process all that complexity to come up with a deal everyone was happy with,” said Mike Patterson, a managing director at HPS.

Bombardier said it had “extensively considered several different financing options” and ultimately decided on a private deal “because it provides more flexibility at a competitive cost”. HPS underwrote the full $1bn commitment in July, before later bringing in Apollo and Ares.

Even more big-cheque deals could have arisen, executives say, were it not for the market-calming measures enacted by the US Federal Reserve to buy corporate bonds and slash interest rates. That enabled troubled borrowers such as cruise operator Carnival to raise money in the bond market instead.

“I think everyone was a bit surprised at how quickly the rally took away some of those larger capital opportunities,” said Kipp deVeer, head of credit at Ares Management.

But medium-sized businesses, which Mr deVeer said have “less flexibility in the public, liquid credit markets”, still offer significant opportunities, he added.

Via Financial Times