SiteImpact and First Legal, for example, are both in the process of migrating from the non-sponsored to sponsored universe, and they look poised to issue some relatively borrower-friendly debt.

Site Impact has been in talks to raise a $200m financing package priced at between SOFR+525bps-550bps to fund a private equity buyout. First Legal has been drawing interest from PE firms with lenders willing to go as low as 450bps over the benchmark.

But the difference in borrowing cost for the two types of companies is tightening for a number of reasons, according to 9fin sources.

One reason is the most obvious: lackluster LBO volume. The lack of deals in the sponsor-backed market — where most private credit deals get done — has put more attention on non-sponsored deals, where activity is still happening.

“When you [non-sponsored] are like 5% of the market transactions on a normal basis, but there are no other transactions to do, everyone wants to focus on the 5%,” said one private credit portfolio manager.

Meanwhile, founders, owners, and management teams are finding success in playing a competitive market to secure deals at lower rates.

The premium on sponsored deals has narrowed 75bps-100bps in the last few months, according to multiple 9fin sources who are active in the non-sponsored space. Meanwhile, pricing on non-sponsored deals relative to historical norms has fallen around 30bps, they said.

Millwood Hobbs, head of sourcing and origination at Oaktree, summed up the current dynamic: The sponsor market is "probably [SOFR+]475bps to 525bps on a class A private credit deal, the non-sponsor is probably 525bps to 600bps."

Hold the line

While the regular way private credit market is racing to compete with banks on pricing (among other things), the 500bps mark remains a meaningful threshold.

"If I brought a 475bps [non-sponsored] deal to the rest of my investment committee, I’d get thrown out of the company," said the PC portfolio manager mentioned before.

Traditionally, non-sponsored deals have been less competitive and have a wider range of potential borrowers when compared to the PE-backed market. They are also higher-yielding compared with PE-backed deals because of the perceived risk profile of lending to a company without a private equity sponsor involved.

There’s also the due diligence process, which often involves third-party collateral providers assessing assets and balance sheets for non-sponsored companies. Sponsored deals, for instance, are completed in two to four weeks, a non-sponsor deal may take up to eight weeks, Hobbs said.

“Some are tied to public shareholders and boards, and it's more of a hand-holding process and trust,” he said. “I'm trying to get to know you as a potential capital provider. So there's just more of dating, if you will."

The $3trn opportunity

In spite of the shrinking premium, demand for private loans to non-sponsored companies looks set to grow further.

A recent white paper from Turning Rock Partners, a private credit firm focused on non-sponsored deals, predicts more than $3 trillion in borrower demand for such loans over the next three years, with asset-heavy areas being the most attractive sectors, including transportation, communications, and industrials.

The report estimates that there are more than 200,000 US middle market companies with annual revenue between $10m and $1bn. Most of those don't have private equity or private credit backing.

“It’s a growing and sophisticated market that has experienced increased demand from the banking market disruption but also has grown because the end customer, meaning the owners of growing businesses, prefer bespoke solutions,” Turning Rock Partners CEO and founding partner Maggie Arvedlund told 9fin.

While the opportunity set remains theoretically large, banks do remain formidable in the non-sponsored space. Their presence may stymie private credit’s growth in the sector, even in spite of lingering effects of last year’s regional bank crisis.

Aaron Kless, managing partner and CIO of Andalusian Credit Partners, which lends to both sponsored and non-sponsored businesses, told 9fin that approximately 80%-90% of leveraged loans to non-sponsored companies in the broadly defined middle market still comes from banks.

Nevertheless, Kless expects private credit will increase its presence in the non-sponsored segment of the market. In some cases, it is because banks aren’t willing to be as flexible as direct lenders, he added. In others, it’s simply that regional banks are pulling back from corporate credit.

Momentum, therefore, is there for private credit.

“We're in much earlier innings of the share shift that we’ve seen in the sponsor-backed market,” Kless said. “Looking forward, there is no doubt that non-bank lenders will continue to gain share from banks in the non-sponsored market, which presents a significant opportunity for direct lenders which can underwrite and execute these types of deals.”

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