When the Federal Reserve and other central banks initiated a period of aggressive rate hikes in 2022, banks reduced lending to lower-quality corporate borrowers. But as interest rates have started stabilizing and central banks put monetary tightening on hold, banks have started to come back into the market and lead financings.
According to PitchBook LCD data, 21 companies issued broadly syndicated loans this year so far to refinance $8.3bn of debt that was previously provided by direct lending funds. The data provider said that this has meant that the broadly syndicated loan (BSL) market has taken back more than $19bn worth of loans that were repaid in favor of private credit last year. While this number is already meaningful in context of a lower volume 2023 we had, we believe it will only grow as call protections on the more expensive private deals from 2022/2023 start running out in 2024.
The banks are currently able to offer borrowers compelling refinancing offers on the back of a strong CLO bid for syndicated loans and a significantly better bond market than the one we had in the past year with appetite for tight pricing both for secured and unsecured tranches.
The average spread on new or repriced loans issued to borrowers rated B-minus or B3 was S+420, which is a four-year low, down more than a point from S+535 in the first quarter of last year, PitchBook found.
Perhaps, MDP-backed UK insurance broker, Ardonagh, is a good recent example, where a $5BN+ financing which previously was expected to be entirely arranged privately by an Ares-led group of direct lenders, to make it the largest private deal ever done, eventually had the private component reduced to c. $3BN, with $2BN+ moved to the USD / EUR bond market by a bank group led by Morgan Stanley and Goldman Sachs.
The bond tranches had secured USD and EUR components, and a $1BN unsecured USD note, showing the bond market appetite for credits like Ardonagh currently to raise money at an attractive pricing across USD / EUR and also for unsecured debt.
While Ardonagh is a good example of the recent public-private tag team, where more should likely emerge as the competition between the two markets intensifies, private equity firm KKR’s acquisition of healthcare technology firm Cotiviti became an example where banks actually beat the private dealers to finance the 50% stake the sponsor bought in the company from Veritas Capital, while previously having been in talks with both private lenders and banks to finance the transaction.
Growth of private credit
With the increasing number of private players with varying pocket sizes that borrowers can go to for their financing needs, however large or small, it is certain that private credit has become a key part of debt markets and will continue its growth trajectory.
According to latest figures from Preqin, the private credit market is expected to grow to $2.8tn by 2028. And Termgrid’s private capital sentiment survey, published in January, found that 82% of respondents believe that private credit can sustain competition on jumbo financings ($1bn+ deals) with bank-arranged syndicated loans / bonds even as the syndicated market grinds tighter on terms.
With the return of banks, private credit managers are employing several different strategies to ensure that they can continue to win deals and provide returns to investors.
How private credit is competing
Competitive terms and pricing is definitely one tool the private market has been forced to use, and this can be seen with the razor sharp pricings achieved on some of the recent larger deals such as Ardonagh, cited above, but also on smaller credits such as the Rover Group, where Blackstone, via a private deal raised a $250m loan at SOFR+ 4.75%.
Another strategy private credit managers are using is bolstering their specialist lending capabilities. As noted in our survey, direct lenders have grown – with anecdotal evidence that many teams are now larger than origination teams at investment banks. In addition to size, firms are now increasingly looking to specialist expertise by hiring investment professionals sector-specific backgrounds.
For example, firms like Oaktree, Blackstone, Carlyle, have all recently added or are looking to add specialist professional in healthcare, lifesciences, or sustainability space to give them an edge over generalists at banks. Consideration here being, specific sector knowledge, would allow these private lenders to price a financing better than the syndicated market where the level of understanding of the space and / or the due diligence process would be slightly less profound.
In an effort to find alternative avenues for return, some private credit managers are also turning to asset-based finance – an area of the market dominated by banks. While still early days, a Moody’s report suggests that private credit managers will continue to increase their market share by building out their own origination capabilities. It’s an area that KKR previously highlighted as a compelling opportunity. And in February, Blackstone Credit partnered with Barclays to take over its credit card receivables.
Others are providing NAV-based financing or payment-in-kind notes. Whereas some are offering more flexibility or using hybrid structures.
Many private lenders, are also growing their sourcing capabilities, and in addition to having sourcers and / or gatekeepers in key geographies (fund HQs like London) are now also adding sourcing capabilities in smaller individual geographies, to not miss out on those financing to banks who have better local coverage through country bankers.
Changes to terms
There are also those managers who are giving up some protections in their bid to win larger deals.
An analysis by Moody’s of 28 private credit loans and 15 broadly syndicated loans showed that larger deals were starting to increasingly eliminate maintenance covenants. Around two-thirds of deals of less than $250m had maintenance covenants in place. While only 38% of deals of $250m to $500m had them, which fell to 7% for deals larger than $500m.
The ratings agency said it expects the trend to continue as the private credit market competes with the syndicated loan market, where the vast majority of loans do not have covenants.
With rising competition, there is also a risk that other lender protections will start to disappear. Additional protections that private credit funds typically have include IP blockers, for example. But Moody’s expects there to be increased convergence in protections as competition heats up.
Strong relationships
With more than 10k users across the private capital network, Termgrid is well positioned to understand the relationships at play in this sector.
Undoubtedly deals can and will be done based on terms or price but certainty of execution and managing through the lifetime of an asset are also significant.
The last few years have provided private credit the opportunity to become a go-to-product and thrust it into the limelight. During that time relationships have been, not only created, but institutionalized. Sponsors have preferred lenders that they know can support an asset throughout the lifetime of the deal and lenders have large teams actively search for the deals that they want to do.
What price will borrowers put on certainty of execution and familiarity in the face of possible uncertainty in the future? It is hard to put a numeric value on relationships but their value can not be underestimated.
Competition is the best motivation
Private credit grew into the space left in the wake of banks pulling back on lending in the wake of the financial crisis. As such innovation is baked into its very existence.
While BSL has taken advantage of muted market conditions in early 2024, there is no doubt that healthy competition is best for all in the sector.
“It is clear that private credit and syndicated loans are seen as competitive products. That lays the foundations for a healthy and dynamic market which will drive deal velocity for all,” said Dipish Rai, CEO, Termgrid. “It is no surprise that the private credit community is responding to healthy competition and we expect this to continue in 2024.”