Diversification limits in investor agreements mean that private credit funds’ hands are tied when it comes to stumping up more cash for acquisitions or for pure liquidity. And there is no greater demand than at the present, when M&A valuations are depressed, for performing credits to ask for that add-on and to get acquisitive.

“The sponsor wants to begin the acquisition strategy but the existing lenders can’t top up,” said a second fund source.

Take the case of business management software provider Access Group. Only last summer, it was the reported recipient of Europe’s largest unitranche deal, and the rapidly growing business is now having to cast the net beyond its existing club in order to fund a comparatively modest-sized proposed €500m add-on.

“They [sponsors Hg and TA Associates] are talking to new people [lenders] as well as the existing club,” said a third fund source, who is close to the deal. “Many of the club won’t increase their tickets.”

“It’s an excellent credit, but clubs have a limit,” said the first source. 

Pressure on private credit fund managers to restrict their exposure to any one credit to single digit percentages in a fundamentally different market environment within 2023 is clipping the wings of even the most generous club lender, said the two sources. 

A search for a new lender outside of the incumbent gang is often the consequence. Within every investor agreement there is a diversification limit that governs the maximum exposure a fund can take to one sole credit. This sits in the single digits and is typically 1-5%, explained a market source.

Following [the preceding years’] 2022’s large syndication take-downs and jumbo deals, some credit funds will be maxed out. While this is less of a problem for a plain-vanilla unitranche loan, it doesn’t work for any credit that has a buy-and-build strategy.

“We saw papers signed a couple of months ago where the club lenders had gone into a deal and maxed out their dry powder. We were surprised the sponsor had taken these lenders on, as they were planning a buy-and-build strategy,” said a fourth fund source.

Portfolio pressure is a growing preoccupation for private credit funds. A fifth fund active in both club and bilateral deals explained that it has been reducing its ticket sizes over the last year.

“We have reduced for diversity’s sake to 1-2% [per credit], they said. “Even the big funds want to make sure that they’re not making big commitments now.”

Access Group was reportedly split between a £2.3 billion unitranche, priced at L+575 bps, and a £1.2 billion acquisition tranche, provided by Apollo, Blackstone, Arcmont, HPS, GIC, ICG, Park Square/SMBC, PSP, Golub, Owl Rock, Bain Credit and Partners Group.

But there are workarounds

Funds sitting on large allocations of junior dry powder but with scant senior are becoming increasingly frustrated, explained the fourth source.

“They’re responding by seeing if there’s some wriggle room to use their junior allocations for senior debt, in credits they like,” they said.

This often involves digging deep into the terms for their PIK and their HoldCo allocations. In some cases, fund houses with a piece of the unitranche debt are able to enter a junior section of the debt through a separate vehicle such as a credit opportunities fund.

Over in the US, the monster $5.5bn unitranche backing the sale of healthcare tech firm Cotiviti to private equity sponsor Carlyle is reported by Bloomberg to be stitching some PIK into the capital structure. This of course seals the deal for direct lenders over syndicated bank financing, but it is also a way for a fund manager to increase overall exposure to the asset via PIK and unitranche without breaching portfolio diversification limits at the direct lending fund level.

The secondaries market also offers an opportunity for the fund to increase its exposure. 

“There are various secondary market solutions, whether through a fund for a single credit’s growth and add-on purposes, or for selling allocations for disintermediated LPs,” said one private markets source. 

These secondary entry points will only grow as the private debt market travels through its credit cycle. And the appetite to increase exposure is very much there for good credits. 

“We like resilience, recurring revenue, sticky businesses operating mission-critical B2B services,” said a source close to Access Group at the SuperReturn Private Credit conference in London earlier this week.

In the case of the Access Group, Its revenues are growing - 43% total growth in the fiscal year 2022 to June, it reported FY 22 EBITDA of £227m and 89% of its revenue is recurring, growing organically at 21%, according to a source close to the company.

A notable exception to the dialling back is Ares. The credit fund is one of the few that may have the firepower to swallow the refinancing of caravan park operator Parkdean’s GBP 575m TLB and GBP 150m second lien - where it already has exposure in the junior piece. 

But whether it turns its gargantuan appetite in the direction of sponsor BC Partners’ sale of VetPartners, where it is already in the debt, or the $1.2bn refinancing of Ambassador Theatre Group, remains to be seen. And if not Ares to the rescue, then it may require a little shaking and a little dancing to wriggle those junior and senior allocations around a little bit more. 

Ares, Access Group and HG Capital declined to comment. TA Associates did not respond to requests for comment.