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Private Credit 

David Brooke

Shubham Saharan

This article is part of our new service, 9fin Private Credit, which will soon require a separate subscription to view. For more info on this product and the accompanying database, contact subscriptions@9fin.com

Private credit investors like to tout the absence of rating agencies as a perk of the asset class, when they pitch financing to prospective borrowers.

Despite the conflict of interest in the ‘issuer-pays’ model, credit ratings are a backbone of the broadly syndicated debt markets. But they’re expensive, and can cause headaches especially for CLO investors if a deal ends up with a dreaded B3 rating or worse.

Because private credit deals are not public, but instead provided by a club of lenders, new deals largely circumvent the role of ratings agencies — giving borrowers one less cost to worry about, and one less potential bottleneck in a deal process.

But of course, ratings agencies recognize the risk of being left behind in this rapidly growing market and have found creative ways to get involved.

For instance, some are making a business in rating individual loans in a portfolio for the benefit of certain investors (typically insurance firms), 9fin sources say. Transparent third party ratings may also aid the development of a secondary trading market of loans, which JP Morgan is trying to get off the ground, per a Bloomberg report. 

KBRA is also generating business by rating NAV loans, which have garnered plenty of media attention this year.

Meanwhile, S&P recently produced a stress test report on private credit portfolios as we documented here, which modeled three scenarios where EBITDA drops 30% and SOFR drops 1.5%. One source I spoke to was somewhat dismissive of the report, noting this was an extremely unlikely scenario. Nevertheless, it’s a data point that can help monitor the opaque private credit market.

It’s not as though private credit has been walled off completely from the ratings agencies. Middle market CLOs for example are an important avenue of liquidity for direct lenders that are serviced by rating agencies. BDCs also regularly issue rated corporate debt.

But it’s logical that rating agencies want to play a bigger role. This could mean even more blurring of the lines between the BSL and private credit markets, if the latter starts seeing similar ratings. As one source jokes: “It’s private-credit lite”.

The question is, will the rating agencies take on that type of stewardship in the private credit market? Or do they want to avoid coming up (big) short when the asset class has its own crash?

Last week, 9fin reported that Medtronic’s sale of two of its units to Carlyle was abandoned, taking a princely $2.5bn of potential financing from banks and direct lenders off the table. 

This was just the latest example in a string of busted deals in 2023 that were victims of mismatched valuations.

Carlyle abandoning a bid for Cotiviti was one of the larger ones (though another deal with KKR is now on the table); as was Gables Engineering, FDH Aero, and to a lesser extent Health & Safety Institute (although this did find a solution by raising equity capital from Neuberger Berman).

Of course, a sale process never truly dies — every private equity-owned company is always up for sale at the right price. And the expectation is that sales will pick up next year so that sponsors can start making distributions to LPs.

If selling to another firm doesn’t work, there is always the option of moving assets from one fund to another. Wereported this week that PEI Group is moving from Bridgepoint Group’s mid-cap group to its flagship buyout fund, after first looking for outside buyers.

Judging from conversations with sources, these were good assets that fell through the net. So it wouldn’t be surprising to see an external sale re-emerge: Cotiviti is already back on the market and the likes of Medtronic (albeit a spin-out not a sponsor sale) should re-appear soon.

At least that is the optimism of many 9fin sources. It might only take only one more turbulent political event (a general election, let’s say) to rattle markets and upset sale processes — and we’ll be back where we started again.

It’s been an extraordinary year in private credit. More extraordinary than 2022. More dramatic than 2021. More healthy than 2020. More golden?

Yet next year looks like it will be more extraordinary, more dramatic and healthier than 2023. Dry powder is close to $500bn currently; investors want more private credit; and there are plenty of deals in a bursting pipeline, whether it is M&A waking back up or refinancing upcoming maturities.

For more on these themes, check out part one and part two of 9fin’s five-part outlook series on what’s in store for private credit next year. 

The 9fin private credit team is not yet 12 months old, but there is certainly more to come. We wish all of our readers Happy Holidays and a Happy New Year!

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