As we wrote in that article, GPs are not always super excited about LPs getting involved in deals. They’re already busy trying to put dry powder to work — almost $500bn globally, according to data provider Preqin.

But private credit is a relationship business, so managers have to maintain a happy face in front of sponsors and LPs. And with fundraising so competitive, it’s important to be as flexible as possible. 

For LPs, the issue is whether the resources put into underwriting a transaction themselves is worth the benefits. Also, part of the attraction of investing in a private credit fund is exposure to a diversified portfolio of loans: do you want to be massively overweight on one particular asset?

Maintaining standards

We’ve talked a lot about how private credit firms are looking a lot more like banks. Recently dubbed the “New Kings of Wall Street” by the Wall Street Journal, these lenders are being hyped as the agents keeping the credit markets moving. 

Banks used to be in the business of holding loans to term. Today, private credit funds have taken over a lot of that business, as well as providing other products that used to be the preserve of banks (like revolvers). 

But some bad habits are setting in. Maintenance covenants, which for a long time were sacrosanct among private credit firms, are steadily disappearing, according to new data from Moody’s. The rating agency notes that this is particularly true at the top end of the market.

In loans made from the beginning of 2022 to September 2023 just 7% of private credit deals over $500m included a maintenance covenant, according to Moody’s. The figure rises to 38% for loans between $250m and $500m. 

Across the universe of credit agreements, sacred cows are being slaughtered left and right, the rating agency says — albeit in slightly less dramatic terms. 

“Private credit lenders have long differentiated their lending practices from the broadly syndicated loans by emphasizing the superiority of their credit documentation…but as rumblings of renewed leveraged buyout activity grow, we expect to see some of these cherished practices put to the test,” says the report.

It is true that private credit’s hype is being tested more and more. There’s a moral panic about NAV lending (for a balanced take, check out our piece on how Finastra’s equity lifeline was funded by insurance firms) and continued hand-wringing over a lack of regulatory oversight. 

Managers often shrug off these concerns by telling us that they are investing in recession-resilient assets, or have tailored their underwriting to ensure protection through economic cycles (as if that’s a distinctive quality — we’ve yet to find a lender that touts its taste for ‘recession-vulnerable’ companies, or for underwriting that increases exposure to economic cycles!). 

The other support these lenders lean on is their strong relationships with borrowers, which helps keep restructurings out of the courts and under the radar. 

Less charitably, such lenders just have more room to kick the can down the road. Meanwhile, the same kind of erosion of investor protections that occurred during the 2010s (which the broadly syndicated leveraged loan and high yield bond markets may now regret) seems to be cropping up in private credit. 

We’re supposed to haggle

The M&A slump in the middle market is still a problem, although a revival might be on after hitting a low point in the first quarter of 2023. 

The issue is the same: sellers want 2021 prices, but buyers want 2023 discounts. Also, the cost of financing is high, despite all that dry powder in private credit we mentioned earlier.

The broader market backdrop doesn’t help: war in the Middle East, war in Europe, plenty of other geopolitical tension to boot, and economic uncertainty everywhere. It’s not a great time to be trying to sell your company.

Today, we reported on a stalled sales process for FDH Aero. The turbulent macro economic backdrop certainly doesn’t help, but this one is especially surprising given that the aerospace industry has boomed in recent months.

As for bigger deals, what happens with Medtronic will be interesting: a sizeable $2.5bn loan would enable private credit funds to deploy some of the cash they are under pressure to put to work. But against this volatile backdrop, who knows!