Life is getting tougher for private credit funds
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Finance does sometimes offer a free lunch. Trouble is, it tends not to be available for very long. That is the situation in which the private credit industry finds itself. The outsize returns direct lenders made when banks were sitting on the sidelines are no longer on offer. With credit waters becoming choppier, making money will now require skill — and scale.
The problem, for direct lenders, is that they are coming under increased competitive pressure, especially when it comes to providing larger, higher-quality loans. The syndicated loan market is open for business, and banks are regaining share.
Indeed, in the first four months of 2024, US companies refinanced $13.2bn of private debt on the syndicated market, according to PitchBook data. In order to compete in this segment, private credit is having to tighten pricing and water down covenants.
With the larger and higher-quality segment of the market hotly contested, direct lenders find themselves chasing business in less-straightforward areas of the credit market: smaller loans, new leveraged buyouts and refinancings of companies that want the flexibility that direct lenders can offer.
See, for instance, Cerberus-owned Electrical Components International, which recently raised $1.1bn of debt in the private credit market at terms that included the option to pay interest “in kind”, deferring the cash outlay. In total, $5.2bn of syndicated loans has migrated to private credit from the syndicated loan market.
Direct loans are by no means the only sector of the market experiencing a deteriorating risk-reward profile. Spreads on syndicated loans and high-yield bonds have also tightened amid high investor demand — and in some cases by more than those on private loans.
But private credit has recently been flooded with investors, with assets under management reaching $1.7tn at the end of 2023. New money chasing a more contested market raises the risk that yields will compress further. With the credit cycle worsening, as leveraged companies come under pressure from higher rates, life for the industry will become harder.
The upshot of a more commoditised private lending market will probably be greater dispersion in outcomes between the funds that can demand adequate compensation for the risk they take, and those that chase risk to juice up returns. Bigger credit platforms will be under less pressure because they can originate more deals. They are also multi-trick ponies. If leveraged lending as a whole becomes less favourable, the biggest funds will have to scout out better opportunities elsewhere.
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