The Unicrunch — Increasing distress prompts self-reflection in private credit market

Anna Russi
+Shubham Saharan

13 September 2024•4 min read

The Unicrunch is our US private credit newsletter, in which we break down everything from unitranches to ABL lending. Find out more about 9fin for private credit here.

Quality control

Things are not quite right in the private credit market today. One need only look at the taking over of Pluralsightand Sirva in recent weeks to see that cracks are appearing.

Fund managers will tell you they are always preparing for difficult situations. Some credits will be winners and some will be losers and in the case of latter it’s about having the requisite resources and expertise to take ownership of a company.

So it’s perhaps no surprise that at the recent Private Equity Wire conference in New York, distress was on everyone’s mind.

There are plenty of tools in the private credit toolbox to help aid struggling companies. For existing borrowers, lenders have been utilizing delayed draw term loans (as discussed here) or inserting PIK components into capital structures to help ease the pain of higher debt costs.

But views are split on what this may signal about the private credit market itself. At the conference some executives argued that this the result of a steady degradation of terms that will translate into higher risk for lenders and lower recovery rates. Others said this was not synonymous with distress but a highlight of private credit’s flexibility.

As one executive said on the development of synthetic PIKs, they are “not positive developments” but “a lot of smart managers who know how to make sure those numbers look ok”.

What are institutional investors to make of this? For years the market waited for these difficult times so LPs could begin distinguishing between different firms, who for years rode a tide of a healthy lending environment fueled by historically low interest rates.

That time has seemingly come for a clear dispersion in manager performance. Conference attendees spoke of concern about poor fund performance should the distress continue to filter through managers’ portfolios.

“We’re seeing a lot of LP dissatisfaction with the outcomes in their credit portfolios, and then we're also hearing a lot of LPs say [they] are worried about defaults. They are worried about shitty documentation,” said a partner of a private credit firm at the conference.

Here comes retail

Retail investors can rejoice because State Street and Apollo are bringing private debt to the common person.

Earlier this week, the ETF pioneer and alternatives giant announced a new partnership via the SPDR SSGA Apollo IG Public & Private Credit ETF. Per the filing, the new fund will allow 80% of the vehicle's assets to be dedicated to investment-grade debt and a sprinkling of private credit magic courtesy of Apollo.

The ETF is designed to give retail investors a slice of the private credit pie that's usually reserved for the big fish. The fund allows up to 15% of assets to be put into private funds and other niche assets, like interval funds and BDCs.

It's not the first attempt at the democratization of private credit — VanEck and Franklin Templeton already have a few BDC ETFs in the market. Still, if approved, it would be the first ETF that would directly allow investors to take a stake in the underlying credit, as opposed to being limited to investing in a BDC’s equity.

But that's the essential caveat, before private credit goes truly mainstream, regulators first have to approve the new ETF and there may be a few bumps in the road on that front.

For regulators and commentators alike have expressed a degree skepticism of private credit. In April of this year, the IMF warned of "heightened risk" posed by the fast growth of the private credit market, and last year, US senators also sounded the alarm bells.