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Private Credit 

Elijah Jackson

Devin McGinley

Private credit faced many challenges in the second quarter — intense competition from the broadly syndicated loan market, bouts of market volatility, and continued pressure on sponsor exits as M&A activity remained muted.

The battle over pricing and terms between direct lenders and bank arrangers may be the story most starkly shown in the data we’ve collected for the second quarter. First of all, check out the divergence in pricing and risk profile in large-cap credits:

It’s not necessarily a surprise that the competition between banks and direct lenders is most intense among these larger borrowers. That’s naturally where the two camps are going to compete the most.

Still, the extent of the division between the relatively disciplined world of sub-$50m credits and the swing-for-the-fences attitude in bigger deals is something to behold:

This echoes a point that Bruce Richards of Marathon Asset Management made in a recent video interview with 9fin, which was mainly focused on asset-based private credit but touched on traditional direct lending.

9fin interview Bruce Richards, Marathon Asset Management

One explanation for this competitive dynamic is that earlier this year, the rate backdrop enabled banks to push pricing lower and to drag private credit funds with them (indeed, some in the industry are now suggesting that direct lenders have gone too far).

Another explanation is that the M&A market just isn’t what it used to be, which is constricting supply of new-money deals. Signs have emerged that this may be changing, though — buyout volumes are picking up, and acquisition financings represented a large portion of private credit deals in the second quarter:

Another effect the sluggish M&A environment is that it is harder for sponsors to return capital to investors. So as private equity firms trudged a landscape of high interest rates and valuation mismatches in the second quarter, they turned to dividend recaps to return capital to LPs — and direct lenders were more than happy to finance them.

The chart above shows that recap were only a small proportion of the overall market in Q2, but it doesn’t tell the full story: according to our data, there was a nearly 50% increase in dollar volume of private credit dividend recaps between between the first and second quarter of 2024.

This is something of a double-edged sword. Lenders often dislike dividend recaps because they can put risk back on the table just as an investment was beginning to deliver on its promise; at the same time, the syndicated loan market is increasingly nipping at private credit’s heels, and facilitating a much-needed dividend can help strengthen relationships with sponsors.

In some instances, such as Blackstone and Blue Owl’s $2bn financing for Park Place Technologies, the fact that syndicated markets are sometimes less amenable to dividend recaps can strengthen the case for sponsors to migrate their portfolio companies to private credit.

Another story emerging from our dataset is that refinancings and repricings (combined) continued to represent a large chunk of the market in Q2. Once again, this is especially true for larger credits:

Some of those refis were extremely large, such as a $1bn deal for healthcare company Press Ganey led by Blackstone — which, in a nod to the pressure for successful sponsor exits, included a provision allowing early repayment with IPO proceeds.

That deal didn’t quite make it into the top 10 largest deals in the first half of 2024, but if it had, it would been in familiar company. Healthcare and tech dominated the largest private credit deals of H1, according to our data:

Let’s move on to deal type. While junior instruments like preferred equity have gained popularity in recent quarters, senior debt still accounted for the vast majority of deals in our dataset, as you can see in the chart below.

The other big story our deal-type data tells is the popularity of delayed-draw facilities, which these days are almost as likely to fund interest payments (the so-called ‘synthetic PIK’ trend) as acquisitions:

A couple of final points on fundraising. First, the number of funds being raised has plummeted over recent quarters, but the average size of fundraise has massively increased. This is what industry consolidation looks like:

Secondly, fundraising this year is looking a lot healthier than it was this time in 2023. The total amount raised so far in 2024 is nearly equal to H1 21, and while it remains to be seen what the second half of the year will bring, that’s a promising change:

We’ll wrap up the data section of this report here. If you’re interested in the European market, check out our H1 Review here — and if you want to make sure your firm’s deals are reflected in our upcoming league tables, email private-credit@9fin.com and let’s talk!

Financial markets are as much about sentiment and perception as they are about hard data, so we’re closing this report with some commentary from market participants to contextualize the numbers. We welcome debate — if you have different views, please get in touch.

Kevin Meyer, head of origination at Churchill Asset Management

9fin: How would you describe the first half of the year in private credit markets, and what trends are you seeing now?

Kevin: Steadily active. While there was a significant amount of refinancing activity as larger borrowers took advantage of a decreasing spread environment, new-money buyout activity was still active for borrowers of stronger credit profiles and scaled lenders with direct origination sourcing capabilities that can speak to 100% of financing needs. Churchill’s senior lending platform, for instance, is well ahead of last year’s deployment, with activity breaking down as 50% new LBO deals, 30% existing portfolio add-ons, and 20% refinancing.

What are your expectations for deal activity and market performance in the second half of the year?

I expect it to remain active through the second half, particularly given the following factors: LPs are pushing PE firms to sell their winners now so they can justify committing to their near-term next fundraise; bankers are touting that they have a record number of deals in their pipelines waiting to be launched, credit quality dependent; credit managers with larger portfolios are seeing significant add-on activity, even in the slower M&A environment; and there is a record amount of capital on the sidelines, with a $500bn dry powder gap between private equity and private debt.

How have recent macroeconomic conditions, such as interest rate changes and inflation, impacted your lending strategies and portfolio performance?

The main theme in today’s market is ‘selectivity and discipline’. In addition to assessing whether a borrower is viable or if there are headwinds or tailwinds within with a certain industry, we have been running through our projection models a ‘higher-for-longer’ risk-free rate environment for quite some time. This has helped further break out the winners and losers from just a cashflow perspective to decide where a conservative leverage starting point should be and what a downside scenario might look like. If the model can’t handle both of these situations, then we take a step back and likely decline moving forward. We have a highly experienced investment team that has invested through multiple economic cycles together, so collectively we know how and when to pick our spots successfully.

What unique challenges and opportunities do you see in the middle market, and how does Churchill address these when structuring deals?

Without scale and sticky, long-term PE relationships, it’s certainly challenging for smaller private credit managers to access a wide funnel of attractive direct deal flow from sponsors — which in turn offers a significant opportunity for leading managers like Churchill to continue to take share. Bankers have been tight with processes and in today’s environment often require lenders to speak to 100% of the financing without the need for flex to distribute dollars. Given the speed, certainty of execution and capital we can provide over the life of a loan, we find ourselves able to structure deals more favorably compared to some smaller competitors.

With the current economic backdrop, what sectors within the middle market does Churchill find most promising for private credit investments?

As generalists, we benefit from seeing both a wide variety of industries and the ability to leverage our portfolio experience to remain highly selective when new transactions come in. With that said, as of late we have seen an increased number of engineering services companies, given the tailwinds behind the Infrastructure Bill passed by Congress. In addition, we have also seen a number of human capital-like businesses such as outsourced advisory practices (accounting, CFO, fund admin-like services). We find both sectors to have significant tailwinds with the underlying borrower credit cashflow profile well protected from downside risk.

Anthony DiNello, head of direct lending at Silver Point Capital

Anthony: We believe direct lending has firmly established itself as a sound and growing financing alternative, offering a compelling value proposition for both borrowers and financial sponsors. In our view, the direct lending asset class continues to be highly attractive relative to other fixed income and equity alternatives, providing investors with strong and consistent yields with lower risk.

The broad adoption of private credit by investors has led to a significant amount of capital being raised for the asset class. Unfortunately, due to weak M&A and LBO activity over the past 18 months, many direct lenders are sitting on a substantial amount of dry powder, waiting to be deployed. This imbalance between loan demand and supply, coupled with managers being under pressure to deploy, has created an increasingly competitive origination environment across the direct lending space, leading to spread compression and weak credit agreements.

As a result, many of the irrational behaviors that we first observed from direct lenders in 2021-2022 have not only returned to the market but have reached an all-time peak, characterized by significant spread compression and very loose credit documentation. This dynamic is not isolated to private credit, as a similar supply/demand imbalance for loans is in full display in the broadly syndicated market where spreads for B- credit are at their tightest levels in the last six years.

Despite this backdrop, we have remained highly disciplined and selective, continuing to source what we view as attractive investment opportunities. We believe the spreads per unit of leverage and risk continue to be very attractive.

What unique challenges and opportunities do you see in the middle market, and how does Silver Point address these when structuring deals?

We believe our strategy and approach positions us to outperform, irrespective of the market environment. Because our origination model extends beyond the sponsor-only model, we believe our origination engine generates diverse, steady deal flow from unique sourcing channels we have built over 20+ years. Outside the sponsor LBO market, we see significant deal flow from non-sponsored companies. This market is far less competitive and also operates with much less efficiency than the sponsor LBO market. Further, most direct lenders avoid the non-sponsored space because it requires independent credit analysis and more time-consuming due diligence.

The larger opportunity set we seek to access makes us less reliant on financial sponsors compared to the broader private credit market. As a result, we are comfortable saying no to deals, even in heated markets like the one we are in today. We believe this gives us a competitive advantage to generate alpha, especially in volatile market environments.

What are your thoughts about the importance of structuring and using financial covenants in loans?

In our view, there is a misconception that ‘good structure’ in direct lending means simply having a covenant in the credit agreement to avoid the label of covenant-lite. The reality is much more nuanced. While financial covenants can be helpful in ensuring downside protection, the mere fact that your credit agreement has a financial covenant is not enough. In our opinion, it is critical that lenders are thoughtful around the financial covenant levels and the structures of these covenants to make sure they come to the table early if a borrower underperforms.

We have seen time and again ‘covenant-wide’ structures, which describes a situation where there is a covenant set well outside of enterprise value and which therefore does not really protect downside risk early enough. We also seek to ensure that we have an appropriate EBITDA definition to enable the financial covenants to work as designed. We often utilize other de-risking tools such as scheduled amortization or covenant step-downs, which can be very effective in specific situations with borrowers.

Finally, as a lender, we believe you have to be intently focused on expansive collateral protection and perfection, closing all potential loopholes that a borrower could otherwise access to fundamentally impact a loan. For years, we have seen the private credit market look past these document shortcomings, but we believe with increased headwinds to borrower performance, sponsors are more likely to access these loopholes to exert leverage over lenders. Overall, protecting the downside on direct loans goes far beyond just the financial covenant question.

With the current economic backdrop, what sectors within the middle market does Silver Point find most promising for private credit investments?

Our success over the past 20+ years, investing across various credit and business cycles, is predicated on our disciplined approach to investing and our fundamental underwriting of companies. We emphasize strong structuring and documentation in seeking to protect capital and minimize losses.

We are industry-agnostic and are able to consider less competitive parts of the market and out-of-favor industries. We believe we have the in-house expertise to underwrite and structure custom financing solutions for borrowers across sectors. We see a wide range of potential transactions, including take private opportunities, carve-outs of businesses from large corporations, refinancings, or incremental add-ons for M&A, in addition to multiple non-sponsored opportunities.

As I mentioned earlier, there is a significant refinancing opportunity for healthy and strong performing businesses currently owned by PE sponsors. Sponsors’ limited ability to monetize these investments today, given valuation gaps and higher rates, has created a pipeline of highly attractive opportunities. Also, given the increased volatility in the public markets, we expect to see additional opportunities for direct lenders to refinance broadly syndicated loans.

Meanwhile, there are sectors where we remain more cautious, such as consumer-focused businesses, businesses with significant customer or supplier concentrations, and certain subsectors within healthcare.

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US Private Credit Review Q2 24 — The battle for large-cap credits

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