PDF | Research | Week of March 18, 2024

Now that the liquid loan market is opening, albeit with mostly refinancings, larger issuers have more choices. This is actually a good and natural thing. For those companies willing to go through the ratings and syndication processes in the bank market, terms can be competitive. 

Because CLO equity investors benefit from much higher structural leverage, BSL pricing can be cheaper than private debt. This illiquidity premium (or liquidity discount) is historically 100-300 bps, depending on ratings. For quality borrowers, particularly in the tech space, leverage can also be higher. And of course, covenant-lite is the standard for syndicated loans. 

The paths borrowers can take depend on a number of factors. Because market and economic conditions have moved to risk-on, liquid loan buyers are positioned to hold single-B, even weak single-B, assets. Retail funds are now seeing cash inflows, with $1.2 billion garnered over the past five weeks, according to Morningstar Direct.

After months on the sidelines, issuers are capitalizing on a favorable environment by refinancing higher-cost structures incurred in the past two years. As our Chart of the Week shows, pent-up activity has shifted dramatically from private lenders to the syndicated world. 

Legacy BSLs have their own refi rhythms. A lot depends on the secondary market. If prices rise (moving inversely to spreads), as they’ve been doing for the past twelve months, it’s easier to take out the loans with a new cheaper deal. If prices fall, as happened last week on the heels of tougher CPI data, it’s a headwind for new primary transactions.

This dynamic underlines the difference between public and private credit and how investment bankers behave differently than asset managers. Rate and economic conditions largely determine BSL appetite. At the moment, those are favorable, so that’s good news for issuers. But as we saw in 2022-23 the pendulum can swing back. And when that happens, the liquid market shuts down.

Much has been made in the press of private debt loan spreads contracting in 2024. But during the Fed rate hikes that began two years ago, those same spreads increased. How did that happen? Simple supply/demand. Doesn’t that same rule apply to BSLs? 

In the bull market leading up the GFC, as interest rates rose, loan spreads actually declined. When Libor peaked at about 5.5% in June 2007, single-B large cap spreads were in the 225-250 bps range, roughly half of where they started in 2003. Supply/demand still ruled, but rate hikes then were more modulated, giving borrowers time to shop. Sponsors also pushed hard to keep all-in interest costs within a band over the period. 

Financing choices now include leading private credit managers who offer a wide range of credit solutions, including those for borrowers challenged by high interest rates. In some cases, this will be a convenient off-ramp for BSL loans. A glimpse of the future bank/non-bank ecosystem.

Private Capital Call Podcast

Episode 4: Edward Goldstein, Partner and CIO of Coller Credit Secondaries

"Secondary market is at a stage where it’s starting to show a level of consistency in transaction volume." - Edward Goldstein

The reversal of refinancings between direct lenders and the liquid market is dramatic.

Contact: Ryan Brown / PitchBook LCD

Our research indicates investors are keeping faith with mainstream strategies – at least for now.

Conservatism appears to be the driving force for many investors in private debt, our LP Perspectives 2024 Study suggests. 

When it comes to fund strategy, direct lending has long been the most favoured option for investors – and nothing in our latest test of opinion suggests that is likely to change any time soon. Nearly half (45 percent) of investors plan to invest more in direct lending in the next 12 months than the last 12, with mezzanine and distressed debt/special situations the next most popular options at less than 20 percent. 

In a podcast with Private Debt Investor, Reji Vettasseri, lead portfolio manager for private markets investments at Decalia, a Geneva-headquartered wealth management specialist, reflected on the findings of our study and said he wasn’t too surprised by the dominance of tried and trusted firms and strategies. 

He noted: “We are living in this period where the biggest firms with the most

classic strategies have been seeing the biggest level of growth… the very big firms focused on direct lending are growing faster. Sometimes they call it the ‘age of the dinosaur’, it’s a place where the bigger the better, the people who can eat everything and be more aggressive have actually done very well over the last few years.” 

He added that he sees this as natural in a fast-growing asset class where plenty of investors are in the early stages of building out a private debt programme. He questions whether this is the right approach over the long term, however. 

“The dinosaur works when there are lots of feeding opportunities around but if you think about how markets might evolve, if you have too much capital in a certain place and when private debt starts becoming a very large proportion of the leveraged finance market in traditional LBO financing, it’s harder to generate a return premium.” 

According to preliminary results from LSEG LPC's quarterly middle market lender outlook survey, a large majority, nearly 70%, of respondents think that there will be a moderate increase in M&A activity in 2Q24, compared to 1Q24. Another 26% expect M&A activity to be flat next quarter. Most middle market lenders felt they did not lend as much as they

wanted to in 1Q24, citing the lack of new M&A as one of the main factors. Forty-seven percent of survey respondents say the main impetus to kickstarting M&A activity is that valuations need to come lower while another 29% answered interest rate cuts are needed for M&A to pick up further. 

Contact: David Puchowski / LSEG

Both EV/EBITDA and EV/revenue multiples tell a similar story for middle markets: Valuations reached their apex in 2021 and have declined sharply ever since. Middle-market PE deal multiples are now down 25.0% to 40.6% from their peak, and unlike the overall M&A market, there are no signs of bottoming. Most of that damage was done in the past year. EV/revenue multiples on middle-market PE deals announced in 2023 landed at 2.0x for 2023, down 23.1% from 2022. EV/ EBITDA multiples finished at 11.0x, down 15.5%. Similar to deal volumes, we have returned to 2017 levels for valuation multiples in the middle-market space.

Contact: Garrett Black / PitchBook

Contact: Eric Rosenthal / KBRA DLD

Middle Market & Private Credit

What Investors Want to Know: Middle Market CLO Manager Assessment Considerations

Given the increased interest and overall expansion of the private credit sector, Fitch Ratings highlights key elements of its assessment of the capabilities of middle market (MM) CLO managers that are different (due to relevance) from that of a broadly syndicated loan (BSL) CLO manager. Fitch currently rates MM CLOs by 17 different managers, ranging from large platforms with loan assets under management (AUM) of $60+ billion to less than $10 billion.

In the report ‘What Investors Want to Know: Middle Market CLO Manager Assessment Considerations’, Fitch discusses various assessment considerations it considers unique to managers of MM CLOs. Specifically, four key areas are noted, including capital resources, origination and track record, underwriting and monitoring, and risk management.

Download Report

Contact: Brad Hamner / FitchRatings

Launched Volume

New-issue Yields

Weekly Fund Flows

Weekly fund flows source: Lipper

Contact: Robert Polenberg / LevFin Insights

Debtwire Middle-Market

The blue line in the chart is the current dividend yield of the *VanEck BDC Income ETF (currently at 10.7% as of 15 March, down from the highest level in last 12 months of 12.1% in May 2023) that tracks the overall performance of publicly traded business development companies (BDCs, lenders to privately held middle-market businesses that tend to be below investment grade or not rated, with most lending comprising of senior secured loans). The brown line displays the BofA Merrill Lynch US High Yield (US HY index - currently at 7.6% as of 15 March, decline from the highest level in last 12 months of 9.5% in October 2023), which tracks the performance of USD denominated below investment grade corporate debt publicly issued in the US.

In February, CPI (not seasonally adjusted) increased to 3.2%, from 3.1% in January. Given the rise in inflation which is still above the FED’s targeted inflation of 2%, March rate cuts (meeting on 20 March) seem to be unlikely. 

The spread of BIZD dividend yield minus the US High Yield (shaded area in gray) shows the premium/discount of middle-market loans over traditional high yield. As of 15 March, BIZD dividend yield was at a premium of 311bps to the US High Yield Index, 39bps above the 1-year average of 272bps. The premium for middle market, to some extent, depicts illiquidity for private loans and the credit risk associated with middle market companies. The spread of BIZD dividend yield minus the 2-year treasury (shaded area in light blue) stood at 600bps as of 15 March, below the 1-year average of 642bps.

*As of 29 February 2024, BIZD’s weighted average market cap stands at USD 4.9bn, with PE ratio of 8.28 and PB of 0.99, with the entire portfolio holdings in publicly traded BDCs. Click here for top holdings.

Contact: Suneet Chandvani / Debtwire 

Private Debt Intelligence

Private debt investments provide LPs with reliable income streams through contractual repayments, which are particularly attractive in an uncertain macroeconomic environment. Portfolio diversification and high-risk adjusted returns were the second most common reasons cited by investors surveyed by Preqin for allocating to private debt.

Whilst LPs do not look to the asset class for high absolute returns, the world’s largest listed alternatives managers, who provide the earliest insight into private markets performance, delivered double digit returns from private debt in 2023. The returns were higher than those the same managers delivered from private equity.

For more, read Preqin’s Insights+ Report: Strategy in Focus: Real Assets Debt.

Contact: William Bennett-Lynch / Preqin

Contact: Stefan Shaffer / SPP Capital Partners