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Bells and whistles

Private credit firms are being hit left and right by the banks right now, whether it is on the new origination front (where banks can offer lower pricing) or on existing deals (where direct lenders are offering to shave off up to 100bps from coupons to stave off BSL refinancings).

But even if it is cheaper pricing that is the winning factor today on which way a sponsor goes, it is not the only metric private equity firms use to select their lending partners. (For if it was, there would be no private credit market.)

Direct lenders may not be able to match the pricing of banks, but they can make up for it in other ways, with a variety of concessions and other bells and whistles that can sweeten terms for borrowers while maintaining the yield that LPs expect from the asset class.

We saw an example of that late last week, with private credit puling out all the stops: the $1.2bn refinancing for Granicus, which was won by direct lenders such as Antares and Oak Hill Advisors.

The deal structure includes an $880m term loan priced at SOFR+525bps, dropping to S+500bps should the company deleverage to 6.25x from opening leverage of 7x. It also includes a PIK feature and a portability clause, two prime examples of the sort of maneuverability that sponsors value highly, and which can give private credit firms a leg up over banks.

“Certainly aggressive,” was the way one lender close to the deal put it. It’s exactly the kind of flexibility private credit likes to market itself on — but at what point does flexibility cross the line into mispriced risk?

The deal was more than 3x oversubscribed, so clearly many firms wanted in. But with fewer opportunities out there as banks dominate the market, this deal suggests that private credit firms — with mountains of cash to deploy — are feeling the heat.

Playing defense

We’ve covered some of private credit’s favored sectors before — healthcare and tech, obviously, and of course HVAC. You can now add aerospace and defense to that list.

One of the key plus points in this sector is that the government is often a big end customer. This is good for stability, since (perhaps the chagrin of some libertarians) the government isn’t going away any time soon.

As we covered in our sector analysis earlier this week, the government is a much less volatile customer than others, and offers contracts that provide a high degree of visibility and certainty on earnings. These contracts typically last for three to five years, and incumbent providers have very high odds of renewing those contracts for much longer periods, according to sources.

Stability and steady cash flows: music to a credit investor’s ears.

The sticky nature of government contracts also reflects the higher hurdles that come with contracting for the Department of Defense. Getting vetted and eventually winning a contract is often a lengthy and complicated process for these companies and their backers. But once you’re in, you’re in.

The ESG question looms large over defense investments, especially for European investors, where ESG regulation is more advanced and less fragmented than in the US. But the eruption of several armed conflicts in recent years have forced a bit of a rethink around these principles.

As Kirk Konert of AE Industrial Partners, a defense-focused PE firm, told 9fin: “The war in Ukraine opened the eyes of Europe and European investors.”

Nevertheless, ESG is subject to its own culture war. Depending on which state you’re in, it’s either fashionable or could land you in prison. It’s one reason, perhaps, that many lenders prefer to stick to less controversial sectors such as healthcare and tech.

The ghost of AIG

Earlier this week, US regulator and acting comptroller of the currency Michael Hsu highlighted several risks to financial stability posed by — you guessed it! — private credit.

In his speech, Hsu pointed to several specific risks that have developed as the industry has evolved. For example, the increasing popularity of evergreen fund structures, which he noted can heighten redemption risks (these structures are not dissimilar to open-ended bond funds, which have been cited as a concern by the FSOC and SEC before).

Hsu also flagged private equity’s increased hold over the insurance sector, arguing this has helped fuel the rise of private markets. The comparison he drew was not the most flattering:

“The intermingling of funds and opacity of inter-affiliate risk transfers is reminiscent of practices at AIG before it collapsed in 2008,” said Hsu. “Since PE firms are not subject to consolidated supervision, it is not possible for regulators and other outsiders to assess how risky and interdependent these activities are.”

Quite how to resolve the suspicions of regulators and government officials around private credit is anyone’s guess. But as private credit grows, it becomes harder for participants to claim it is not a structurally significant part of the global financial markets. A crash in private credit would reverberate far and wide through banks and other investors — even if the shockwaves don’t reach depositors.

But it is still hard to imagine what regulation would look like. As 9fin has reported, some of the bigger managers will welcome clear guidance, which would certainly be a step up from the drip feed of warnings/concerns/alarms/general expressions of nervousness from policymakers.