What’s in a name?

Where does senior debt end and unitranche begin? How does stretched senior fit in? How do you define the middle market?

Private credit has grown so fast since the 2008 financial crisis — especially in the past few years — that the language can barely keep up. But what is clear is that a structural change has taken place in the world of leveraged finance: private credit is here to stay, no matter how you define it.

In fact, the way some people talk about it you could be forgiven for thinking that private credit has entirely replaced bank-led leveraged lending. This is not the case. Even David Golub, founder of one of the largest private credit institutions, said at a recent CLO event that the broadly syndicated market will have its “day of revenge”.

The dynamic between ‘public’ markets and private credit is like a seesaw. Conditions sometimes tip in favor of banks — which have a dramatically cheaper cost of capital but are in the moving business rather than the storage business, and therefore very price-sensitive — while other times the certainty of execution offered by private credit can outweigh the generally higher cost. 

These days, sponsors like to play both markets against each other regardless of which way the seesaw is tipping.

Currently, it seems…kind of equally weighted? Banks were able to pluck deals for Titan and Copeland (née Emerson) back from private credit, but non-bank lenders may potentially bring Finastra into their world as the company weighs up $1.5bn-$2bn second lien PIK facility. 

A few weeks ago, many private credit sources were saying they had become more selective; more recently, leveraged finance bankers have started telling us that direct lenders are slashing their pricing and being more flexible on terms. Both are probably true, but the market certainly feels more competitive than it did in the first quarter.

Out of the shadows

Markets have short memories. Even so, it truly seems like aeons ago that $200m-$300m unitranches were seen as frothy deals, and the $1bn facility that Qlik Technologies raised in 2016 — the deal that sparked the term ‘jumbo unitranche’ — is a distant memory.

Speaking of market vocabulary, private credit firms have mostly shaken off the derisory label of ‘shadow banking’. Today, they are being positively (some might even say too positively) embraced by institutional investors. 

Perhaps as a result, the specter of regulation now looms large. Central bankers in Europe and the US have warned of mounting risks, and Senator Elizabeth Warren (no fan of the LBO market) and seven of her colleagues in DC have called for greater transparency in the private credit market.

“Troublingly, there is limited data on fund size and fund activities, and almost no data on the fees assessed by the fund,” the senators said in a letter dated 14 May.

For market veterans, it’s no surprise that more regulation might be coming. At a recent industry conference, Ken Kencel, the CEO of Churchill Asset Management, called it the “biggest threat” the market faces:

We’ve raised so much capital that we’re a solution to larger and larger companies. The real threat is regulation [that] would ultimately curtail that. And allusions to shadow banking are not really informed about direct lending. The fact [is that] we’re raising capital based on performance and track record. It’s fantastic in terms of providing capital — absolutely regulation is the biggest threat.

The devil’s in the retail

Another factor in this greater scrutiny is the growing trend of private credit funds chasing retail money. 

Many lenders (including Kencel’s firm) have launched new private BDCs to pull in cash from both high net-worth individuals and mom-and-pop investors, expanding the market to a new investor base that has historically been locked out.

Not so long ago, Hamilton Lane moved into the world of the blockchain to open the door to retail investors. Investors purchase tokens (somewhat akin to shares…but also quite different) to get access to a number of private funds, including some private credit vehicles.

Attempts to expand private markets to retail investors have come before, without widespread success. For Stephen Nesbitt, CEO of Cliffwater and author of “Private Debt: Yield, Safety and the Emergence of Alternative Lending”, we’re now into a second phase where such efforts are more likely to prevail:

The new second wave of alternatives democratization is now in full swing, having begun in earnest years ago. This second wave has a much better chance of success because, from an investment perspective, it relies on the long-standing return liquidity premium from the private markets rather than trading securities in the public markets.

Regulators always get fidgety when retail investors get involved. There isn’t much transparency in private credit; how is the average American supposed to decide whether a unitranche loan to a mid-western HVAC company at SOFR+600bps is appropriately priced?

It’s a conversation that is perhaps overdue. At $1.4trn in size and set to almost double over the next five years, private credit has become a permanent fixture in debt markets. If Warren et al get their way, it may face its own Dodd-Frank moment.