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Private Credit 

Peter Benson

Just when we thought the upper end of the market had been quiet, two massive tech deals came this week, including a record private debt deal.

Today, news broke via the Wall Street Journal that CoreWeave, an Nvidia-backed AI cloud computing startup has snagged a $7.5bn debt financing package from a group of lenders led by Blackstone, Carlyle, BlackRock, Magnetarand CDPQ, among others.

The financing is easily the largest in the private debt market this year and is likely the largest private financing ever. It at least eclipses the $6bn financing package Vista-backed software firm Finastra got last year.

Meanwhile Squarespace, which is famous for its incessant podcast advertising strategy, took on a sizable amount of debt to back its take-private by Permira earlier this week. The $6.9bn acquisition is also among the largest LBOs this year and provides support to the argument that the private credit market is still a compelling option amid a strong bid from the syndicated market.

For in the absence of large-cap M&A, which has been in depressed levels for around two years now, private credit lenders have been forced into doubling down on refinancings and add-on activity. What few LBOs reach the market are commanding quite a tight spread.

Squarespace, for instance, has obtained a $2.65bn financing package backed by a club of direct lenders, which include Blackstone, Blue Owl, and Ares. The facility consists of a $2.1bn term loan, $300m delayed-draw term loan and a $250m RCF, according to a Bloomberg report. It’s priced at a tight SOFR+500bps, which includes a 25bps leveraged-based step down.

We’ve seen the 500bps mark breached in the last few months, as a dearth of M&A, combined with a strong bank market puts the pressure on lenders. It’s particularly true at the top end of the middle market where financings for Avetta and Higginbotham breached that threshold, as 9fin previously reported.

It was only 12 months ago when lenders said they would not go below SOFR+600bps. But rates are not looking like they will move anytime soon, so private credit firms are reconciling themselves with the new reality.

Yet at what cost? If margins go tighter then it impacts the illiquidity premium funds like to market themselves on. Historically, it was around 150bps-200bps over the bank loan market — any lower and some LPs may want to consider the type of risk they are taking on investments in portfolios of loans that are difficult to trade out of or are exited at the whim of the sponsor.

With SOFR still above 5%, yields on senior secured debt are still in the double digits. By historical standards for private credit that’s a handsome return. But how much lower can spreads go if reaching return targets for LPs can suddenly be upended by a sudden new twist in Fed policy.

“M&A is pretty weak,” said one source. That may not change soon.

But for a take on M&A prospects specifically in tech sector, why not give a listen to an interview with Oliver Thym of Thoma Bravo on Cloud9fin — free of any Squarespace ads.

What happens at the top ultimately filters downwards. Pricing compression is happening at all levels of the market.

Take this week’s news of litigation services provider First Legal. The firm’s auction is drawing interest from both private equity and private credit firms through a sale process. It is being marketed off a $20m EBITDA.

The expected $100m financing package is being talked in the SOFR+500bps range. However, lenders 9fin spoke to said that they had pitched up to 50bps higher than that and had been told the market was tighter. By the same token, there have been pitches below the 500bps range, suggesting competition is fierce.

Of course, credit investing is more than just about the numbers. Even if a company has an eight-figure EBITDA, it does not necessarily mean it is riskier than one that tops $100m (as many middle market lenders will tell you).

There are other factors to consider like sectors, the company’s market position, the prospect for growth, plus many more which go into judging the quality of an asset.

When cash flow is tight, a company may need to take a little less traditional route towards financing.

Indeed, higher interest rates are putting some businesses under pressure. For example, logistics company Quantix is feeling the squeeze on cash flow, sources said, but sees no reason to halt its acquisition spree.

This week, 9fin reported the company received an $80m second-lien financing from Marathon Asset Management to fund future acquisition. But it was no ordinary form of junior capital. The logistics company agreed to an all payment-in-kind structure with an 18% coupon. The reasoning behind this was that the company could keep the cash and forego any immediate interest payments.

Quantix is not operating in a vacuum. Cash flow is a pressing topic around the industry, as recent BDC calls show.

“It’s fair to say that the full impact of an increase in the interest rates has now been reflected within the cash flow metrics of the portfolio,” Matt Freund, president of Barings BDC, said on the fund’s most recent earnings call.

Interest coverage is varied across BDC portfolios. Multiple, including Blackstone and Apollo’s MidCap vehicle, reported some companies under 1x interest coverage ratio.

In the case of BXSL, it admitted that three-quarters of its companies under 1x were companies with sub-$50m in EBITDA. Jonathan Bock, co-CEO of BXSL, said on its call that in the wider private credit market, 16% of borrowers are under a 1x interest coverage ratio.

All this is worth paying attention to in the next few months, as rates remain elevated. For now, the solutions might just be to carry on that buy and build strategy — just avoid adding further to the debt costs.

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