BDC earnings season is upon us, with the ranks of public filers continuing to grow thanks to several listings in recent weeks.

Results came through from Oaktree Specialty Lending Corporation, Golub Capital BDC and the largest publicly traded BDC, Ares Capital Corporation.

Often seen as a bellwether for the broader market, Ares’ results give us a peek into what’s going on in private credit portfolios. 

For the most part, BDCs appear to be telling a similar story to previous quarters: interest coverage ratios have remained relatively steady, portfolio leverage is beginning to inch down, and amendment activity remains strong. 

But some cracks are starting to appear within portfolios. Liquidity is drying up and default rates which have so far defied economic gravity may be normalizing.

From ARCC’s CEO Kipp deVeer on their last earnings call: 

“In the bottom quartile of our portfolio, and probably everybody else's, you have some companies that are making interest payments but continue to live off of revolver ability, cash, etc, but the liquidity is getting tighter and tighter,” he said. “So my expectation is that defaults will go up this year, probably more towards the historical norm.”

We’ve been hearing for a few quarters now that defaults are expected to rise as companies grapple with higher interest rates. Still, there’s likely more pain to come as the rates remain at a heightened level (even with expected cuts).

Bad Blood between banks and private credit 

It’s been all over the headlines — banks are luring deals back from the private credit market. Here’s a few examples:

• UK insurance broker Ardonagh launched a $2bn-equivalent cross-border syndicated deal alongside an expected $3bn private credit financing, after reports the company was in talks for a $5bn, all-private credit transaction
• Auto repair chain Crash Champions priced a $1.3bn bond and loan package to refinance its private loan
• Wood Mackenzie, an energy consultancy, is replacing its private credit debt with a $1.32bn loan led by Bank of America
• Even Waupaca Foundry’s recent $360m term loan, which seemed ripe for direct lenders, instead opted for a BMO-led financing in the syndicated market

But as another famous musician David Byrne asked: how did we get here? 

For public markets, 2022 and parts of 2023 proved to be rough. An unprecedented number of interest rate increases, an inflation spike, a constant fear of recession, and geopolitical uncertainty led to depressed origination volumes in the broadly syndicated market. Private credit lenders were quick to swoop in during this time, offering certainty of execution and a mountain of deployable dry powder, albeit at a higher price point. 

Now, banks are back in business as a steep rally in credit markets enables them to pitch cheaper financing with looser covenants.

But private credit firms aren’t about to lose their recently earned market share so easily. Direct lenders are offering to shave 30bps-50bps from their existing loans to pre-empt refinancing proposals from banks, according to 9fin sources.

They’re also willing to back dividend recaps. One example of a recap was for Astatine Investment Partners-backed Big Truck Rental Company, which is looking to raise debt to refinance an existing subordinated debt facility and fund a distribution to shareholders.

Perhaps an enticing alternative for sponsors to a NAV loan?

Don’t Blame Me for doing another add-on 

Last year was arguably the year of the add-on. Nearly two-thirds of private credit firms’ deal activity in the last few quarters have come from add-on loans. It’s often the core of many private equity strategies, and in the absence of headline LBOs it has been a fruitful strategy for private credit firms.

It also makes a lot of sense for sponsors, as the necessity of holding onto assets for longer has meant focusing on growing their existing portfolio companies.

Private credit is built for such a model, in the sense that direct lenders can fund add-on loans much quicker to facilitate acquisitions compared with the longer lead times in syndicated markets.

It’s also a reliable way for lenders to boost origination volumes. After all, they know the companies, the due diligence is done and dusted, and it’s a good opportunity to deploy until the next wave of dealmaking comes along. 

To track the potential add-on financing activity, we’ve been documenting public records of M&A bolt-on activity and searching through public records within 9fin’s BDC database to find the existing holders of the buying company’s debt, and the potential financiers of any add-on loans. Take a look and tell us what you think!