Increasingly, it feels like bankers are boasting about the mandates they didn’t win. But such relief may only last so long. As a managing director-level banker recently told us, “we’re all going to get caught in this sooner or later.”

Placing secured debt with institutional investors has become a far more laborious process than most syndicate banks are accustomed to. When it comes to unsecured paper, you practically have to give it away.

It’s bad news all round for the sellside. But imagine how much worse it would be if private credit funds weren’t stepping in to take down some of this paper!

Right now, it’s pretty much a given that any buyout financing, regardless of size, will involve such lenders in some capacity.

Smaller deals have been the domain of direct lenders for a while now. As for larger ones, banks are doing everything from privately placing big slices of unsecured debt (Nielsen) to bypassing the syndicated market entirely and going exclusively to private credit funds (Norgine).

It’s not just LBOs. By today’s standards, the pricing Carvana got on the unsecured bonds it sold (barely two months ago) to fund its ADESA acquisition seems like a bargain. But it felt shockingly wide at the time — and how much worse would it have been without Apollo?

These are not small companies or small tranches. Gone are the days when the private credit industry was content with financing regional dentistry roll-ups with $50m of EBITDA; many of them now want bigger clients, and some of them probably want the entire capital stack.

“Private credit has raised so much money in recent years that it is no longer about getting the small company premium,” said Steven Oh, global head of credit and fixed income at PineBridge Investments.

“The premium most private credit managers are getting is the ability to displace the syndicating bank with speed,” he said. “It is a different proposition overall.”

This evolution in the ambitions of private credit simultaneously results from and is boosted by today’s uncertain market backdrop. It’s a perpetual motion machine, where pain for the banks means gains for private lenders, and those gains beget more gains.

To put it another way (as we discussed in last week’s episode of our Cloud 9fin podcast) direct lending is now firmly embedded in the leveraged finance system, right from from the point of underwriting.

New breed

In this new-look market, the lines between broadly syndicated debt (what many refer to as ‘public’ markets) and private credit have become blurred.

The term ‘direct lending’ isn’t as easily interchangeable with ‘private credit’ as it used to be. For one thing, it’s often factually inaccurate — direct lending suggests there is no intermediary, which is not the case when banks are placing debt with a club of private funds, as with Norgine.

On the other end of the spectrum, firms occasionally intervene in broadly marketed deals, as with Apollo’s anchor order for Carvana. When private funds take a big slice of a public syndication (as opposed to displacing it entirely) it’s not really a private credit deal.

Another example of this gray area is Kofax’s buyout financing, in which a handful of private credit stalwarts (including Antares, PSP Investments and Blackstone Credit) were formally listed as co-arrangers on the company’s buyout loan, alongside traditional investment banks.

According to Bloomberg, the private credit firms bought half of the TLB prior to the broader syndication and also took down a $350m privately-placed second-lien facility.

It’s tempting to try and coin a new term for this new breed of dealmaking. We won’t do that; we just want to emphasize that it’s a complex and extremely fluid market.

A less novel but extremely important breed of private credit transaction is the giant unitranche-style financing. These continue to get bigger and bigger — they generally feature a small club of funds, a rotating cast of private credit’s most influential names.

The latest example of this trend is the Zendesk buyout, which is reportedly backed by $5bn of debt provided by funds including Blackstone, Apollo, HPS and Blue Owl. It includes a funded term loan, a revolver, and a delayed-draw component.

Buyout dealmakers often take a dual-track approach to financing these days, exploring both private credit and syndicated options from early in the auction process.

Divergence

What you might call ‘traditional’ direct lending still exists: loans made by firms like (in no particular order) Monroe, Golub, PineBridge, FirstEagle, and Crescent. Such funds often take pains to present themselves as painfully responsible, even boring.

“We are a going-concern cashflow lender,” said Doug Lyons, head of middle market direct lending origination at PineBridge. “We are not looking at any sort of distressed situations. We will run from that in a flash.”

Stability and conservatism are also a selling point of this asset class. In theory, these lenders are supposed to have a long-term outlook and be free of pressure from leverage providers and ratings agencies — two things that distinguish them from syndicated lenders.

"A lot of broadly syndicated loan capital comes from CLOs, and they have leverage and are ratings dependent,” said Michelle Handy, head of portfolio and underwriting at First Eagle Alternative Credit’s direct lending business.

“Private credit has no leverage, or moderate levels of it, and is not ratings driven, so it is typically more stable through market disruption or bad earnings,” she said.

In terms of deal size, these firms have largely displaced the lower end of the broadly syndicated credit markets. That happened well before the pandemic, despite the best efforts of investment bankers who made a last stand for that territory back in 2019.

“The days of $50m EBITDA companies coming to our market are pretty much gone,” said Jeremy Burton, a portfolio manager on PineBridge’s leveraged finance team.

But there’s a growing community of funds whose ambitions extend far beyond this cohort of corporate America. The first big wave of these deals came in the first summer of the pandemic (see this piece, published back in 2020) with the likes of Expedia, Airbnb and Albertsons.

That momentum never really disappeared. The syndicated market staged something of a comeback as government and central bank stimulus drove down borrowing costs, but big-ticket private credit transactions continued to set new records for size.

Russia’s invasion of Ukraine, and the chaos it seeded across global financial markets, created another opportunity for these funds — like Blackstone, HPS, Ares, and Apollo — to take yet more market share.

“Underwriter economics are attracting deeper pools of capital, as traditional debt financings get more competitive,” a credit analyst told 9fin. That’s a jargon-heavy way of saying what’s really going on: private funds are behaving more and more like investment banks.

Partner or predator?

Before the pandemic, the relationship between private lenders and broadly syndicated credit was often described in adversarial terms. This was a battle for territory, in which direct lenders were supplanting the investment banks and siphoning away their fees.

The new breed of big-ticket private lenders prefer to pitch themselves as partners, not just of the firms they lend to but also of the investment bankers they used to see as foes. It’s like a collaboration between a boutique fashion house and a mass-market clothing brand.

To borrowers (or ‘clients’) these firms present themselves as long-term backers with an almost equity-like mindset: they want the business to thrive and grow, to share in the journey (and the upside, if possible). But you also know they’ll fight like hell to cap their downside at par.

For firms like Apollo, which gained notoriety in the credit world for loan-to-own distressed lending and innovative/aggressive financial engineering of portfolio companies, this is something of a vibe shift (the ‘partner’ pitch, at least).

Meanwhile, investment banks seem to have begrudgingly accepted that they’re going to have to share the market with these cash-rich behemoths. In fact, it’s gone beyond that: in order to clear the buyout backlog, the banks need these funds.

This is also a big change. It’s like some unlikely alliance between two warring families in Game of Thrones — the enemy of your enemy is your friend, especially when the new enemy is taking a big loss on an underwritten bridge and possibly losing your bonus/job.

Bagholders

In that sense, it really does feel like the syndicated markets are dependent on private credit. At the very least, it seems unlikely that the territory the private funds have claimed is going to be retaken by the syndicated markets for quite some time.

"It would be a challenge for the broadly syndicated market to get that share back,” said Handy at First Eagle. “What we've seen won't reverse itself, and as more capital is raised and the really big players continue to expand their wallet, they'll continue to take market share away from broadly syndicated loans.”

The current malaise afflicting CLOs doesn’t help matters. At the moment, a lack of appetite for triple-A paper is keeping a lid on new CLO issuance, which is down significantly from last year’s record levels.

In turn, that means there is less of the ravenous appetite for leveraged loans that fueled the hot primary market last year. If CLO issuance bounces back, perhaps the dependence on private credit will ease.

Another thing that might level the playing field is a recalibration (upwards, obviously) of return expectations among investors in private credit funds. As Bloomberg reported this week, private credit has become cheaper than syndicated debt; how long can that really last?

Also, let’s not forget that there’s a reason borrowings costs have shot up. The economy is faltering, and in credit terms, many of the companies private credit firms have funded in recent months look much shakier now than they did earlier this year.

“The reality is [these lenders] have an element of excess risk,” said Steven Oh at PineBridge. “At some point we are going to see some of those transactions blow up, and I actually think that will be a pretty good outcome for the market overall.”

Ouch! But he’s got a point. Investment banks get paid to shift risk, while private credit funds are paid to hold the bag. As painful as today’s LBO wipeouts might seem, they are small change compared to the potential losses if one of these deals goes under.