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Cometh the opportunity, cometh the opportunistic credit fund.

Cometh many of them, in fact. The term ‘opportunistic credit’ has been around for years, but after Covid arrived and upended world markets it became ubiquitous. So much so that we decided to examine what the term actually means, and how that has changed.

In the years before the pandemic, opportunistic credit was almost a dirty word. For the second half of the 2010s, markets were relatively stable and interest rates were low, so there were few opportunities to generate outsize returns.

It was the era of manufactured defaults, of getting primed and J.Screwed. For participants in the regular-way performing debt markets, opportunistic credit funds were among the perpetrators of these brazen maneuvers.

“It used to be a phrase that carried almost scary connotations,” said Jennifer Daly, head of the private credit and special situations group at King & Spalding, of opportunistic credit. “It was viewed by some as practically predatory.”

That’s changed a little in the past couple of years, however. When Covid hit, markets became severely dislocated — suddenly, opportunistic funds didn’t have to work so hard to create opportunities. As companies of all stripes cast around for emergency financing, opportunistic funds went from being seen as predatory to becoming vital financing partners.

Over the past few months, successive waves of volatility have presented more such opportunities. Russia’s invasion of Ukraine, the resulting mountains of hung LBO debt, the UK pension debacle, the Silicon Valley Bank meltdown. For a time in 2022, the primary markets could barely function without big private credit funds, many of them with variations of the word “opportunistic” in their name.

Recent fundraises show how popular this strategy has become with investors. Just last month, Blackstone closed its fourth tactical opportunities fund at $5.2bn, and Oaktree announced it was aiming to raise $18bn for its latest opportunistic credit fund.

“Every time we go through a down cycle all these opportunistic credit guys show up,” said Bobby Lau, a partner at Carl Marks Advisors.

The proliferation of such funds has led to what one credit market veteran called “definition creep”.

“For a long time it was associated with distressed and hedge fund and private stuff,” said the person. “Now it’s like any time you can generate double-digit returns, people call that opportunistic.”

That doesn’t sit right with everyone. Aaron Peck, co-head of the opportunistic credit group at Monroe Capital, argues that it’s misleading to suggest that opportunistic credit investors are always taking more risk.

“It is a fact that opportunistic credit deals tend to be higher returning deals and as a result, many people will equate that with the deals having more risk,” he said. “But my view is that isn’t necessarily the case. It is a higher perceived, not actual, risk.”

If that argument implies that the risk in question is being mispriced, that’s kind of the point: opportunistic funds have come to represent a more accessible source of liquidity for companies going through tough times, for whom more conventional funding sources are closed and/or uneconomical.

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Take, for example, the construction of a whole new office building. That is typically financed with a high-cost construction loan and eventually refinanced with a cheaper loan once the building is generating income.

But in today’s capricious return-to-office environment, commercial real estate is an unloved sector. It is hard for developers to get attention from traditional lenders when refinancing — but an opportunistic credit fund might identify a city with exponential growth and very low vacancies, look at buildings with strong pre-leasing performance, and get comfortable with the risk.

Where others focus purely on the risk, such a fund might be able to take a view on the underlying promise of the asset, and be willing to extend a loan as a bridge to better days.

This example is playing out in the markets right now. Many traditional US office markets are struggling to attract buyers and lenders alike on office properties. Enter the opportunists.

“Borrowers are looking to partner with opportunistic credit funds because they are well-positioned to help a ‘good company, bad balance sheet’ situation, as opposed to coming in and extracting profit,” said Daly at King & Spalding.

The volatile nature of markets since the pandemic has created more opportunities for these funds to deploy capital, said Andreas Boye, managing director and co-head of credit opportunities for North America at Carlyle.

“Opportunistic credit primarily focuses on delivering capital solutions to companies and real asset classes, which have a challenging time accessing the traditional credit markets,” he told 9fin. “For structural reasons, including more stringent banking regulation, that population of borrowers has grown significantly over the past 15 years.”

Take Finastra, one of the big private credit dramas of 2023. The company has faced some earnings challenges, but there are signs it is starting to turn things around; however, its balance sheet was overlevered, making a refinancing of its existing syndicated debt difficult.

It took a while for a deal to materialize, but in the end it did — with a structure that the regular-way syndicated markets probably wouldn’t have gone for. Buoyed by an equity injection from Vista, the company’s sponsor, opportunistic private credit funds stepped in to lend.

Yet the dreaded ‘D’ word is never far away. Although, seemingly the language has caught up that there is a clear dividing line between distressed and opportunistic lenders today, that to some extent can be treated with skepticism.

This dislocated and volatile market environment has blurred the lines between performing and distressed; there are plenty of companies out there with strong businesses whose exposure to rising interest rates makes their capital structure unsustainable.

“A while back, the majority of the funds that labeled themselves as opportunity funds were really just distressed debt funds,” said Peck. “Over time, it has changed and there are more opportunistic credit funds that have a broader mandate than just distressed debt.”

But there is a key difference. Opportunistic funds are theoretically more incentivized to help a company work through issues as a going concern, as opposed to positioning themselves to profit from a company entering bankruptcy.

This can be helpful for sponsors in the current environment: having privately held debt, without publicly visible trading levels, avoids the taint of distress and makes negotiating with lenders easier.

Moreover, many companies are so highly levered in today’s market that there’s little profit to strip in a bankruptcy.

“When a company got into distress 15 or 20 years ago, there were still assets on the books that were leverageable,” said Lau. “We've gotten to a point today where a lot of these businesses are so fully levered that you can’t carve out an asset and get a loan against it to help you through the bad times. There are no available assets left.”

With interest rate coverage ratios falling to unhealthy levels, opportunistic credit funds have become an important source of funding for those wanting to avoid defaults. Perhaps the popularity of such funds has even helped the default rate stay low.

Essentially, they’ve become many borrowers’ first port of call, argues Daly: “Instead of lenders of last resort, they're lenders that people keep front of mind.”

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