Competition between the private credit and broadly syndicated loan (BSL) markets is intensifying, with developments on both sides blurring the distinctions between the two products. One of these distinctive features is the delayed-draw facility, which was traditionally a feature of the private credit market but is now seen with some frequency in the BSL space.
Delayed-draw loans are committed, unfunded term loan facilities that provide a borrower with the option of drawing down on the facility over an extended period of time (typically up to two years).
During periods of elevated interest rates and higher borrowing costs, delayed-draw loans have been an attractive option for borrowers. These facilities allow borrowers to avoid paying interest on unused debt (aside from a customary ticking fee), while ensuring that financing is readily available to facilitate acquisitions and other permitted expenditures.
Historically, delayed-draw facilities have been predominantly offered by private credit lenders. Private credit funds first started offering delayed-draw finance to mid-market, private equity-backed companies that were pursuing buy-and-build strategies involving multiple add-on acquisitions through the life of the loan.
Since private credit’s origins lie in the sponsor-backed mid-market, delayed-draw facilities became a standard feature of many private credit structures, as they dovetailed with the investment strategies of many mid-market sponsors and borrowers.
Providing delayed-draw options has proven more difficult in the BSL market. BSL loan tranches can often include more than 100 underlying lenders, each holding a small portion of the loan. This makes administering a delayed-draw facility much more complex, as loan agents must coordinate with every lender at each draw-down, and borrowers face the risk of funding delays or shortfalls if all lenders do not fund promptly when required. By contrast, a traditional private credit lender will typically be the sole lender, or part of a relatively small lending group, which makes the logistics of delayed-draw facilities significantly easier to manage.
BSL investors also generally prefer to put money to work immediately. They do not usually want to commit financing that will only begin to generate yield once it is drawn down by the borrower. In particular, CLO investors, who are a major buyer of syndicated loans, typically prefer to avoid holding committed but undrawn capital due to negative tax and ratings implications and the negative carry associated with holding capital to fund the commitments.
Private credit funds also prefer to have loans generating yield from day one. However, because they operate through a fund structure, they are more comfortable offering delayed-draw facilities, as the fund’s capital is not deployed—and therefore not accruing opportunity cost—until the manager issues a capital call. This means that even if a delayed-draw agreement is in place, the fund isn’t tying up capital or losing yield in the meantime.
BSL markets adapt
Despite the challenges that issuing delayed-draw facilities present for the BSL market, investors and arranging banks have adapted. To remain competitive with private credit, they are increasingly offering delayed-draw flexibility to borrowers.
To mitigate the risk of lost yield on undrawn commitments, investors typically cap the availability period and incorporate ticking fees into the loan documents. For example, the availability of delayed-draw debt is typically capped at between 12-24 months, while a ticking fee will typically apply, often set as a percentage of the margin that would apply for drawn loans with step-ups over time. Private credit lenders will also use ticking fees and cap the availability period, although on slightly more generous terms, with the ticking fee often accruing at a fixed rate of 1.00% per annum (sometimes subject to an initial holiday period).
In addition, investors typically require that the delayed draw facility can only be drawn if leverage on a pro forma basis is less than or equal to a negotiated level, often set at the closing level. Further, the parties will often negotiate the permitted use of proceeds of the delayed draw facility. Often, the use of proceeds is limited to permitted acquisitions and other similar investments; however, broader examples have been seen in the market—in some cases including capital expenditures or even general corporate purposes, though generally excluding dividends. Some delayed draw facilities may also allow the proceeds to be used to replenish balance sheet cash or revolving credit facility drawings that were previously used for such purposes within a certain time period.
The payment sequence and timing for upfront fees is also a negotiated point for delayed draw facilities. In many cases, 50% of the upfront fee will be payable at closing, with the remaining 50% only paid if and to the extent that the delayed draw term loan (or a portion thereof) is actually funded.
The delayed-draw PIK play
The BSL market is also in some cases using delayed-draw loans to offer additional flexibility to issuers, most notably if the form of payment-in-kind (PIK). PIK provisions allow borrowers to add the interest owed on debt to the principal balance of a loan, instead of paying the interest in cash. This can be especially helpful when interest costs are high, and cash flows are under pressure.
Private credit funds have long been more willing to provide PIK flexibility, a valuable differentiator in a tight credit environment. For the BSL markets, offering PIK terms has been more difficult, as many syndicated loan investors are often constrained by mandates that limit their exposure to instruments that do not pay interest in cash.
To work around this, the BSL markets have been able to structure delayed-draw facilities in a way that offers borrowers PIK-like flexibility. Rather than adding the interest payments directly to the loan principal, these “synthetic PIK” facilities allow borrowers to tap a delayed-draw facility to cover interest costs.
While private credit funds still have an edge in offering delayed-draw and PIK options to issuers, BSL markets are adapting quickly. By incorporating elements of the private credit playbook into their own offerings, the BSL markets are able to remain competitive and provide borrowers with similar levels of flexibility.
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