There’s a range of use-cases: risky companies hoping to extend their lifelines, existing shareholders seeking liquidity, existing lenders looking to derisk their investment, and healthier companies/sponsors trying to do debt financings in tough market conditions.

Here are some other recent examples:

• Equinox is seeking around $400m in preferred equity — and getting good demand for it — in addition to a roughly $1.3bn new loan to address its upcoming maturities, as 9fin reported earlier this month. Direct lenders are trying to get involved
• Franklin Energy Services recently swapped out $125m of junior debt with preferred equity in an attempt to push out upcoming maturities and deleverage the business. The investment was provided by Invesco
• Vista Credit Partners pumped $200m of preferred equity into Globalization Partners, a company backed by the firm’s private equity team
• In the case of Consolidated Precision Products, both the lenders and the sponsor pitched in to close a deal in December. Ares Management and CPP’s private equity owner Warburg Pincus provided $750m of preferred equity with a roughly 15% yield, while a group of direct lenders provided a more than $1bn loan

For investors, the ability to do prefs is a double-edged sword. If all goes well, there are higher potential returns on offer; some regular-way lenders even look to provide prefs in tandem with a slug of more senior capital, as a way to juice their returns.

Pref providers can also obtain some governance rights, like the ability to push for dividends or force a sale process. The aim is to walk the line between taking on more risk and thus getting a higher return, and securing enough downside protection to mitigate losses.

And that’s the rub: you might be able to wangle some protections in a pref, but the risk is still a lot higher than in senior lending.

Gimme! Gimme! Gimme!

In 2021, an onslaught of competition for deals led to looser covenants for lenders. Then, as markets cooled in 2022 and 2023, the pendulum swung back in favor of private credit firms.

This wasn’t all one-way movement. As we documented last June, there were periods of deal drought during which lenders lowered their standards again — but broadly speaking, protections held steady.

Today, the resurgence of syndicated markets and growing competition for a smaller selection of deals has some direct lenders bending over backwards again:

From FS KKR’s Q4 earnings call on Tuesday:

“You’re getting less access to what I would call financial covenants, but you're lending to better companies. I think we're sort of comfortable with that,” said Dan Pietrzak, CIO of FS KKR, referring to deals with $250m or more of EBITDA.

“There will be certain […] sectors or size of companies where we would only do the deal with the financial covenant,” he added. “With larger companies we will be a little bit more flexible there, because we're gonna like the credit risk.”

The data bears this out: Moody’s last year found that just 7% of private credit deals over $500m in size included maintenance covenants, whereas smaller deals have more protection. And there is far less evidence of creative LME methods like collateral-stripping and uptiering in private credit than in syndicated debt.

From Blackstone Secured Lending Fund:

“When we negotiate our credit agreement, especially when we're the leading lender, we place significant focus on ensuring important protections are put in place,” said Jon Bock, co-CEO of Blackstone Secured Lending Fund, during its Q4 earnings call on Wednesday.

“Nearly 100% of the Blackstone led deals held in BXSL include certain protections against asset stripping and collateral release and have caps on add-backs to EBITDA.”

Still, you have to wonder how long direct lenders can hold the line. Banks are already able to offer far better pricing, and sponsors love the flexibility offered by the syndicated market’s looser covenants. In a market like this, it’s tough to keep standards high and deploy capital.

Knowing Me, Knowing You

How can you really know a market that was designed to be…somewhat unknowable?

Recent private credit data paints a confusing picture around defaults and interest coverage. This, and the much-discussed inconsistency around valuations in private credit (most recently by our friends over at Bloomberg) should not be a surprise!

Just like private equity, private credit was built to be flexible, and to operate free of the scrutiny of public disclosures and the tyranny of mark-to-market. Of course the defaults will pushed out; of course the data will be patchy, and the valuations inconsistent.

All that is true, but: as interest rates remain elevated and borrowers continue to seek reprieve via PIK amendments and extensions, getting at least some idea of the health of the middle-market is quite important.

A new KBRA report on this suggests that between revenue and cash on hand, companies with private credit debt still have a decent amount of wiggle room to navigate the current era of high interest costs.

The median borrower in KBRA’s model of the private credit universe has $183.8m in revenue and around $27m of EBITDA. That puts the borrower’s leverage ratio to about 6.4x, while the EBITDA to interest ratio (EBIT to interest costs) is 1.8x. Even in KBRA’s stress scenario, the median borrower still has 1.3x interest coverage.

Interestingly, that average interest coverage figure is a bit higher than what was stated by some of the BDCs that have recently reported for the fourth quarter.

For example: at FS/KKR interest coverage came in at 1.5x, while Ares Capital Corporation reported weighted average interest coverage of 1.6x, and Goldman Sachs BDC said its weighted average interest coverage was 1.5x.

For context, interest coverage of around 2x is generally seen as a healthy measure.

Meanwhile, Lincoln International’s latest report on fixed charge coverage ratios, which indicate a firm’s ability to meet mandatory expenses (EBITDA relative to fixed charges such as leasing costs and debt interest and principal payments), shows a slightly more concerning landscape.

At the end of 2021, borrowers in Lincoln’s sample set had a 1.57x weighted average coverage ratio. By the end of 2023, that had dropped to 1.07x which Lincoln said was “slimmer than ever”.

Plenty of people and institutions are raising concerns about private credit, including the Bank of England. It’s easy to dismiss this as scaremongering, but these numbers do genuinely suggest the shine might be coming off the golden age of private credit.

Enjoyed this article? Our customers receive news and analysis ahead of the crowd on the 9fin platform. To try it out for yourself, click the button below.