Life for Private Credit Funds is Becoming More Difficult - Latest Global News

Life for Private Credit Funds is Becoming More Difficult

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Sometimes in finance, you can actually get something for free. The problem is that it’s usually not available for very long. That’s the situation the private lending industry finds itself in. The above-average returns that direct lenders earned when banks were on the sidelines are no longer available. With the credit situation becoming increasingly volatile, making money now requires skill – and size.

The problem for direct lenders is that they face increasing competitive pressure, particularly when it comes to providing larger and higher quality loans. The syndicated loan market is open for business and banks are regaining market share.

In fact, according to PitchBook data, U.S. companies refinanced $13.2 billion worth of private debt in the syndicated market in the first four months of 2024. To remain competitive in this segment, private lending companies must tighten their pricing and loosen their loan covenants.

As the larger, higher-quality segment of the market becomes highly competitive, direct lenders are looking for business in less straightforward areas of the credit market: smaller loans, new leveraged buyouts, and refinancings of companies that want the flexibility that direct lenders can offer.

One example is Cerberus-owned Electrical Components International, which recently raised $1.1 billion in debt in the private debt market. The terms included an option to pay interest “in kind” and thus defer the cash outlay. In total, $5.2 billion in syndicated loans have moved from the syndicated loan market to the private debt market.

Direct lending is by no means the only market sector where the risk-return profile is deteriorating. Spreads on syndicated loans and high-yield bonds have also tightened due to strong investor demand – in some cases even more than on private loans.

But private lenders have been flooded with investors recently, with assets under management reaching $1.7 trillion at the end of 2023. New money pouring into a more competitive market increases the risk that returns will fall further. As the credit cycle tightens and leveraged companies come under pressure from higher interest rates, life will get tougher for the industry.

The result of a more standardized private credit market will likely be a greater dispersion of results between those funds that can demand fair compensation for the risk they take and those that take risks to increase returns. Larger credit platforms will be under less pressure because they can do more business. They also have greater versatility. If leveraged lending becomes less favorable overall, the largest funds will have to look elsewhere for better opportunities.

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