Introduction

North Carolina has established itself as a powerhouse in the banking and financial services sector, earning its reputation as the second-largest banking centre in the United States, after New York City. Anchored by the city of Charlotte, which serves as the headquarters for major financial institutions such as Bank of America and Truist Financial, the state boasts a thriving and diversified economy with a highly skilled workforce concentrated in the financial, technology and healthcare sectors. With its geographically strategic location, supportive business environment and strong ties to growing fintech and technology industries, North Carolina continues to play a pivotal role in shaping the nation’s financial landscape and trajectory.

The lending market in North Carolina is driven by traditional commercial banks. Although private credit and alternative direct lenders have become more prominent over the last decade, commercial banks continue to serve as an essential source of capital for growing and established companies. Lending activity originating out of North Carolina is also national in scope and industry-agnostic, and, as such, recent trends witnessed in North Carolina are in many respects the same as those impacting lending markets more broadly across other financial centres in the United States.

General Economic Trends

Interest rate adjustments

Rate cuts implemented by the Federal Reserve played a significant role in shaping lending dynamics in North Carolina over the past year. While modest in scope, interest rate reductions in 2024 signalled the end of an era of tightening in response to inflation. While the persistence of high interest rates relative to the “free money” era during the COVID-19 pandemic has continued to dampen mergers and acquisitions (M&A) activity, corporate borrowers that opportunistically increased leverage during the “free money” era are increasingly facing the end of scheduled five-year maturities and in need of refinancing.

Regulatory considerations

Following the recent Republican sweep of the Presidency and Congress, the lending community anticipated an easing of regulations, increased M&A activity, and an overall more business-friendly lending environment. However, in important respects the political and supervisory priorities of the new administration remain in a state of evolution. While no material banking deregulatory initiatives have yet been formally implemented, it seems likely there will be an effort in 2025 to reduce capital requirements for smaller banking institutions, and the Treasury Secretary of the new administration has indicated that “all the bank regulations” may be subject to a forthcoming “reexamination”. In particular, the use of governmental power to curtail private sector “diversity, equity and inclusion” (DEI) initiatives has emerged as a top political priority, with the President’s handpicked chairman of the Federal Communications Commission threatening to block mergers involving companies that promote “invidious” diversity policies.

Adding to the present uncertainty, there are numerous cases of the new administration testing the constitutional limits of executive power by acting to fire personnel of independent federal agencies, including two commissioners of the Federal Trade Commission, setting the stage for near-term litigation in the Supreme Court over the separation of powers. Notwithstanding the strong push by the new administration for personnel changes, the chairman of the Federal Trade Commission has emphasised that existing antitrust cases and investigations against large technology companies will remain a priority for the new administration, raising concern among some in the business community as to the influence of so-called “Khanservatives”.

What is reasonably clear at this juncture is that the political and supervisory priorities of the new administration are likely to diverge in important respects from the priorities of both recent Democratic and Republican administrations, including the first Trump administration. Traditional banks will need to remain vigilant in monitoring both domestic and international political developments, address existing supervisory findings, and prioritise attention to corporate governance and public communications (in particular, around DEI and “environmental, social and governance” initiatives) to navigate uncertainties as the new administration’s political and supervisory priorities sharpen into focus over the course of 2025.

Tariffs

Changes in tariff policy under the new administration will continue to have a significant impact on lending activity during 2025, in North Carolina and nationally. When tariffs are imposed, they frequently lead to higher costs for businesses reliant on imported goods or inputs for production and can disrupt long-established supply chains. While the speed and unpredictability of the new administration’s implementation of tariffs may be seen as a geopolitical negotiating tactic, it has also contributed to a cooling of short-term optimism for increased M&A transaction volume, at least for the first half of 2025. To the extent that the precise targets and details of the new administration’s tariff policies remain uncertain, so does the economic impact of tariffs on the bottom-lines of operating companies in affected industries. Buyers and sellers may struggle to agree on the valuation of an acquisition target until the economic impact of tariffs on the company’s existing operations is objectively quantifiable.

Traditional banks are likely to reassess their lending criteria for borrowers with operations concentrated in affected industries or otherwise reliant on heavily tariffed goods as inputs for production. In addition, tariffs may contribute to inflationary pressures, leading to higher interest rates (or extending the timeline of projected interest rate cuts) in 2025 and decreasing aggregate borrowing demand. On the flip side, some traditional banks may see opportunities to finance businesses seeking to adapt their supply chains or invest in domestic production to mitigate tariff impacts. Certain companies will need to rethink their business plans and may need to borrow additional funds to build out facilities or temporarily cover higher production costs caused by the implementation of tariffs.

Private credit versus traditional bank lending

The competition between traditional banks and private credit lenders has intensified as both sectors vie for dominance in the corporate lending market. Private credit lenders, including funds and business development companies, have gained significant traction due to their ability to offer bespoke financing solutions, quicker execution and higher leverage levels. Unlike traditional banks, private credit lenders are not subject to the same regulatory constraints, allowing them to provide more flexible terms and looser covenants. However, traditional banks maintain an edge in offering lower-cost financing and access to broader financial services, such as treasury management. In addition, traditional banks can typically provide loans in multiple currencies, which can be a significant advantage for businesses operating internationally. The convergence of these markets is evident, with private credit lenders increasingly financing larger deals and traditional banks adopting private credit-like strategies to remain competitive.

There has been a recent trend of private credit lenders and traditional banks working together in partnership. Private credit lenders have increasingly partnered with traditional banks to launch private credit funds, allowing traditional banks to leverage the agility of private credit firms while direct lenders benefit from the vast client networks and financial infrastructure of traditional banks. Working in partnership, they may provide a broader array of financing solutions to companies that might not qualify for traditional bank loans, such as highly leveraged firms or those operating in niche industries. As the private credit market continues to expand, these strategic alliances are expected to become more prominent.

Artificial intelligence

The integration of artificial intelligence (AI) in banking brings significant advantages and challenges. On the positive side, utilisation of AI technologies can result in back-office operational efficiencies by automating routine tasks related to loan processing, fraud detection and customer service. Sophisticated in-house data analysis conducted by AI can be used to improve risk assessments in the underwriting process and streamline (or even replace) entry-level analyst tasks. However, there is evidence that mechanical reliance on algorithmic processes may increase (instead of counteract) the risk of biased decision-making, and the use of AI technologies is frequently in tension with mandatory data privacy and security protocols of financial institutions.

There are also numerous examples of AI programs fabricating non-existent data inputs to justify speculative solutions or recommendations proposed by the AI. For example, in the legal industry, litigators attempting to use AI to streamline legal research tasks have discovered – at times only after being sanctioned or fined by a judge – that legal cases cited by AI models in support of legal arguments may not exist. In addition, in banking and other professional service industries, there is concern over the long-term impact that pervasive reliance on AI technologies may have on the training, education and development of junior personnel.

While remaining cautious towards the unique risks posed by AI, most traditional banks are nonetheless testing or incorporating AI technologies into some parts of their business. Striking the right balance between technological innovation and ethical considerations, while taking a “trust but verify” approach to AI-generated data inputs, will be key to maximising AI’s potential while mitigating its drawbacks.

Transactional Trends

Loan issuance activity

A significant portion of new issuance volume in the bank lending market has historically been driven by private equity-backed leveraged buyouts. For most of 2024, less than favourable market conditions prevailed for leveraged buyouts, primarily due to high interest rates (relative to the “free money” era during the COVID-19 pandemic) and increased antitrust scrutiny under the Biden administration. As a result, refinancings and dividend recapitalisations played a dominant role in driving loan issuance volumes in 2024. These constraints on M&A activity in 2024 are anticipated to continue through at least the first half of 2025, and the economic impact of newly implemented tariffs and associated supply-chain disruptions are likely to further dampen M&A activity in the short-term. As a result, most operating companies and private equity sponsors will continue to be focused on refinancings and dividend recapitalisations in 2025 and will be reluctant to engage in transformative debt-financed acquisitions during the first half of 2025, given the overall weak M&A market and uncertainty of deal valuations due to tariffs.

Loan documentation terms

EBITDA add-backs

Negotiations around EBITDA adjustments in loan agreements have focused on speculative add-backs for yet to be realised, or difficult to quantify, benefits and the extent to which such add-backs should be capped. While lenders have shown increased flexibility in permitting uncapped (or more loosely capped) add-backs for permitted acquisition and other identifiable, non-recurring expenses, they remain cautious towards run-rate cost savings and synergies, typically requiring such add-backs for private companies to be subject to an aggregate percentage of EBITDA cap.

For public companies, such add-backs may be permitted to the extent in accordance with Regulation S-K of the Securities and Exchange Commission, often with a separately capped permission for other run-rate cost savings and synergies. Revenue-based adjustments, such as the attribution of lost revenue from unforeseen events or the acceleration of future revenue from new product lines or contracts, are also largely resisted by lenders and, if accepted in the context of a particular company’s business model, will be subject to a trailing 12-month aggregate cap as well as temporal limitations. The type and scope of EBITDA add-backs that are permitted, as well as the sizes of related caps, vary based on the size of the company, private equity ownership and industry.

Reallocation provisions

A loan covenant feature gaining increasing popularity and acceptance with higher-quality and private equity-backed credits is a reallocation provision. In its typical formulation, this provision permits borrowers to shift utilised capacity for various types of incurred items subject to negative covenant restrictions (eg, debt, liens, restricted payments and investments) freely among any theoretically applicable basket permissions. The reallocation may be retroactive, permitting the company to shift utilisation from fixed dollar (or other more restrictive) baskets into uncapped, financial condition-contingent baskets at times of optimal financial performance, so that the company’s more restrictive baskets are fully available for future use when performance weakens. Increasingly, reallocation provisions are drafted to be self-effectuating, so that reallocations occur automatically, without any action of the borrower or the lenders.

Lenders in the broadly syndicated loan markets tend to be more accommodating of flexible reallocation provisions, compared to those in private credit transactions. Often in connection with the extension of existing syndicated loan facilities for higher-quality credits, borrowers will request that outstanding utilised capacity be shifted to uncapped disclosure schedule permissions or otherwise grandfathered, effectively reloading all of the company’s negative covenant baskets. If this is accepted, lenders should ensure that the reallocation provision is drafted so as to not function as a blanket waiver of the prior incurrence or carrying of items in violation of the terms of the existing loan agreement.

Grower baskets

A “grower” basket allows the borrower to preserve basket capacity even if EBITDA subsequently declines, since the basket incorporates a fixed dollar floor based on the borrower’s closing date EBITDA. However, if the borrower’s EBITDA improves over time, the borrower gets the benefit of a proportionately larger basket. This concept is important for companies entering into credit facilities with maturities of five years or more, since the thresholds and caps agreed to at the initial closing may become outdated as the company grows over time, both organically and through acquisitions.

A relatively small percentage of loan agreements also include a “high watermark” concept that allows the borrower to lock-in the highest trailing 12-month EBITDA achieved during the term of the loan agreement for purposes of determining available capacity under grower baskets. This concept is not prevalent in the market and is less common in syndicated middle market transactions and private credit deals. However, if a borrower incurs, for example, indebtedness in excess of the “floor” component but in reliance on the “grower” component of an ordinary “grower” basket (without a “high watermark” concept) and EBITDA subsequently declines, such that the amount of indebtedness carried over time exceeds the then available capacity under the basket, it is common to see language permitting the full amount of such indebtedness (that was permitted under the basket at the time incurred) to continue to be carried in reliance on the same basket, notwithstanding the post-incurrence decline in EBITDA.

Liability management transaction protections

Leveraging previously negotiated flexibility built into existing loan documents (often by private equity sponsor owners), sophisticated borrowers encountering financial distress continue to avail themselves of an increasing array of liability management transactions (LMTs) to generate liquidity, fund ongoing operations, and/or stave off a bankruptcy filing. Lenders have become attuned to the reality that when it comes to contractually limiting LMT flexibility within the terms of a loan agreement or an intercreditor agreement, the devil is in the (drafting) details.

Increasingly, broadly syndicated loan facilities may be marketed as having, for example, a “Serta blocker” provision even though the referenced provision in the document would not, as drafted, materially inhibit the structuring of an uptiering transaction. (For example, a “Serta blocker” provision with an exception for “indebtedness otherwise permitted” under the loan agreement as amended from time to time is effectively toothless, and a “Serta blocker” provision that only applies to the subordination of “all or substantially all” of the obligations and liens is of limited value. Notwithstanding the foregoing, both types of “Serta blocker” provisions are in the market.)

For higher-quality and private equity-backed credits, lenders may not be successful in negotiating certain LMT blocker provisions at all. Current market practice around LMTs remains varied, both in the syndicated loan markets and in the private credit markets, and negotiation outcomes often hinge on a borrower’s (or their private equity sponsor’s) situational leverage.

While judicial opinions of a court on the permissibility of LMTs are still relatively rare (as litigation over LMTs is often settled out-of-court), on 31 December 2024, the United States Court of Appeals for the Fifth Circuit held that the now infamous 2020 uptiering transaction involving Serta Simmons Bedding, LLC was (at least in part) not permitted under the company’s then existing loan agreement. For the 2020 uptiering transaction to be permitted under the terms of the existing loan agreement, the non-ratable prepayment of outstanding debt of the priming lenders that occurred as part of the LMT structure needed to qualify as an “open market purchase” under the loan agreement, which term or phrase was nowhere contractually defined. After surveying the use of the phrase in various dictionaries, judicial opinion precedents and industry sources, and applying traditional canons of linguistic construction and interpretation, the court determined that the non-ratable prepayment occurred on a more private market and, as a result, was not an “open market purchase” within the ordinary English meaning of that phrase.

While on the surface the Fifth Circuit’s ruling may be seen as a constraining influence on LMTs (at least of the Serta variety), lenders on the wrong end of such an LMT should take little comfort in the decision. The devil remains in the (drafting) details, and sophisticated law firms will have no trouble remedying the scrivener’s “error” (from the perspective of an LMT advocate) identified by the court going forward in response to the opinion, if their client’s desire is for uptiering transactions to be permitted. As a result of the Fifth Circuit’s ruling, there will be increasing usage of express defined terms to delineate the scope of “open market purchase” provisions as well as alternative drafting means of accomplishing the same economic ends (such as loosening restrictions on borrower and affiliate lender buybacks of outstanding debt). Accordingly, the opinion is not anticipated to result in an abatement of LMT activity.