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Some Find Opportunity in Shrinking Private Credit Markets
When interest rates were low and credit was abundant, private credit markets grew rapidly. The midmarket companies that tapped private credit tended to lack the investment-grade profile of companies participating in the broadly syndicated loans market. However, creditors and debtors benefited from the tighter covenants and higher returns typical of private credit. As interest rates have climbed across the world due to persistent inflation, credit markets have contracted. While private credit has been undermined alongside public credit, there are still areas of strength. Private credit remains immensely popular with private equity firms and midmarket companies looking for capital.
Given the opaque nature of private markets, it can be challenging to compare private credit to the broadly syndicated loans market. However, a recent analysis by S&P Global provides a glimpse of private credit through the lens of credit estimates on middle-market collateralized loan obligations (CLOs) and credit ratings on business development companies (BDCs) that are issuing private debt. Of middle-market CLOs with a credit estimate, about 75% have a score of “b-” and about 10% are in the “ccc” range. Most BDCs do not have a credit rating, but many of the larger, more established BDCs do. Of the BDCs rated by S&P Global, all but one are rated BBB-. This implies that the majority of private credit would be considered speculative grade if it were rated using the same methodologies as public corporate debt.
The riskier nature of private credit has not prevented its adoption by alternative asset managers such as private equity firms. Large alternative asset managers such as Apollo Asset Management, Ares Management, Blackstone, Brookfield Asset Management, The Carlyle Group and KKR have invested roughly $1.4 trillion in credit markets, approximately doubling the allocation of 2019.
As banks have become increasingly reluctant to provide capital in the form of loans to growing companies, private equity has stepped in to provide direct loans through the private market, according to S&P Global Market Intelligence. In a squeezed market for capital, private equity has been able to command higher interest rates and stricter covenants from borrowers, including payment-in-kind loans, which allow borrowers to make payments with additional debt or equity rather than cash.
Take-private transactions funded by private credit have remained very popular even as private equity transactions have declined over the past two years. In a typical year, take-private transactions account for about 20% of private equity deals, but that share doubled to about 40% in 2023. Unlike most private credit, which involves direct lending between borrower and creditor, take-private transactions involve a consortium of lenders, including one “legacy sponsor” that holds existing private debt. Because this debt predates the current increase in interest rates, the cost of capital for the total deal can be kept lower.
Larger private equity firms have used their extensive reserves of dry powder to lend capital when capital is expensive. This has worked substantially to their advantage. According to Jonathan Gray, president and COO of Blackstone, current market conditions have created "a golden moment for private credit."
Today is Tuesday, June 6, 2023, and here is today’s essential intelligence.
Written by Nathan Hunt.
Economy
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—Read the article from S&P Dow Jones Indices
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Capital Markets
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—Read the report from S&P Global Ratings
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Global Trade
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—Listen and subscribe to Capitol Crude, a podcast from S&P Global Commodity Insights
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Sustainability
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—Listen and subscribe to ESG Insider, a podcast from S&P Global Sustainable1
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Energy & Commodities
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—Read the article from S&P Global Commodity Insights
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Technology & Media
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—Read the article from S&P Global Market Intelligence