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“From a very big picture perspective, it’s still looking good.”
– Brian Rose, senior US economist, UBS Global Wealth Management.
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How to Stop Worrying About the Maturity Wall (First of a Series)
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The New Order: Leverage Finance in an Asset Management World (First of a Series) | |
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We were perusing recently a piece on the future of private equity in an excellent state of the market study from Evercore’s private funds group. One of the paragraph section subtitles read: “The corporate governance fix that became an asset class.”
The thesis was that private equity sponsors solve strategic problems for growing (or challenged) businesses by giving management upside in the performance of the company in exchange for capital and corporate support. That fix, of course, has led to the development of an industry that so far has amassed, according to the article, AUM of $14 trillion.
In the same way, we think, private credit has grown from a back-water of middle market lending in the 1980’s to beachfront in the fastest growing element of the capital markets. We would suggest private credit is “The regulatory fix that became an asset class.”
Regulatory bodies such as the Fed, OCC, and FDIC have been pushing against banks for decades to not hold leveraged loans on their balance sheets. The GFC brought a sense of urgency to that mission, and sparked interest and investments in non-banks raising long-term capital and zero consumer deposits.
Post-pandemic private markets have survived Covid shutdowns, supply-chain crises, high inflation, high interest rates and persistent threats of recessions. At the same time, banks further retreated from high-yield credit as liquidity was drained from the financial system. Private credit managers, propelled by investor appetite for consistent, premium yields for less-correlated assets, took over buyout financings with a vengeance.
Today the outlook for higher interest rates has softened. While the timing of cuts shifts with each PDI report, expectations for lower rates later this year still prevail. In the meantime, the BSL market has shown signs of renewal, though mostly in the form of refinancings.
Some have seized on this revival as the first volley in the battle banks are waging to regain lost market share. BofA Global Research (quoted by PitchBook LCD) highlighted $10 billion of direct loans refinanced by banks, thanks to the “DL spread premium over BSL recently hitting 250 bps, the highest in a decade, thereby incentivizing issuers to cut interest costs by rotating into syndicated markets.”
What is the outlook for the private vs. public struggle for corporate transactions? How do credit solutions of these players differentiate themselves? Can banks regain the share of buyouts they lost over the past three or four years? And most importantly, will heightened competition among top lenders lead to increasingly aggressive terms and higher defaults?
Over the next few weeks, we’ll examine these and other related questions in this special series, with the goal of more transparency and better education on both the liquid and illiquid asset classes.
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New: 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
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Expectations for Fed rate cuts soften as the economy remains strong. | |
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Source: The Daily Shot
(Past performance is no guarantee of future results.)
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February 6 & 7, 2024
Encore at the Wynn in Las Vegas, NV
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SFNet’s Asset-Based Capital Conference 2024
Doing What We Do Best
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30-DAY FREE MEMBERSHIP
Join the leading voice of the middle market. Try us free for 30 days.
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Private markets get the nod over the long term | |
Investors are confident in the future of private markets, but fund managers have shown combining public and private market investment through flexible mandates can work well. | |
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Our recently published LP Perspectives 2024 study asked investors to compare prospects for public and private markets over the short, medium and long term. What it found was that respondents favoured public markets over the short term and private markets over the longer term.
The poll recognises the lack of correlation between the two. In times of crisis, public markets will tend to be quicker to take the hit – through marking to market, problems will become visible more quickly and buyers able to take advantage of discounts. This process tends to be slower in private markets, and there is more time to address issues outside the public gaze – they may indeed be dealt with successfully and therefore never surface at all.
During periods of volatility, fleet-footed fund managers will take advantage of relative value plays – switching between
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public and private markets according to where the best value resides at any given point in time. A recent example where that became evident was during the covid period where dislocation funds were raised quickly and with great success by some fund managers on the back of flexible investment mandates. Some of these strategies reportedly delivered strong returns and therefore seem likely to draw even stronger investor appetite in future.
The good news for private markets is that, over the long term, three out of four of our investor respondents were more positive about the private markets outlook than the public markets outlook. In the private debt market specifically, the advances made by private providers of finance at the expense of public sources have been well documented. The march of the private markets is unlikely to slow – regardless of short-term bumps in the road.
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Leveraged Loan Insight & Analysis | |
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US repricing volume totals US$73bn
so far this quarter
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So far this quarter, US repricing volume totals US$76bn, the most since 1Q21, as dozens of issuers have returned to market to cut the spread on their institutional loans. There has been 59 completed repriced tranches this quarter, also the highest since 1Q21. Repricing volume accounts for 45% of total US institutional | |
refinancing loan volume in 1Q24. LSEG LPC defines a repricing as an opportunistic refinancing used for the sole purpose of cutting spread on an institutional term loan. Meanwhile, the average cut in spread for a repriced tranche is 49.2bp this quarter, just under 4Q23's 50bp average. | |
The Pulse of Private Equity | |
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Gross private credit returns/appreciation
by manager*
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The top seven US-listed alt managers with credit strategies—including TPG, as its acquisition of Angelo Gordon (AG) closed on November 2, 2023—posted median Q4 and 2023 returns of 4.0% and 16.4%, respectively, which compares favorably to the 9.8% PE gross returns referenced above. Not all of these private credit strategies may be comparable, with some taking on more risk and leverage than others, but their recent ability to generate equity-like returns with significantly lower volatility has validated the headlong push these managers have made to gain full exposure to the asset class. Of note, the median gross return reported by these seven managers with private credit strategies not only exceeded the median return delivered by their PE strategies, but the differential also expanded from Q3 to Q4.
In commenting on the performance of their underlying portfolio companies, most managers reported a stableto-improving trend in Q4 2023 both in terms of revenue and EBITDA growth—consistent with a soft-landing thesis. Blackstone indicated 7% revenue growth YoY in Q4, a slight downshift from the 8% growth rate in Q3; although, it sees cost pressures fading fast and expressed conviction that inflation is now running below the Federal Reserve’s (The Fed’s) 3% target. In its ARCC portfolio, Ares indicated that TTM EBITDA ticked up from 6% in Q3 to 9% in Q4. ARCC is the largest publicly traded business-development company at present, with more than $13 billion in loans to primarily middle-market companies. Lastly, at the higher end of the growth scale, Blue Owl reported EBITDA growth also firmed slightly from Q3 to Q4 and averaged 15% on a TTM basis. Blue Owl is a leader in the software direct lending space, which partially explains these elevated growth rates.
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KBRA Direct Lending Deals: News & Analysis | |
TTM Default Volume, Count | |
Middle Market & Private Credit | |
Fitch’s Private Middle Market Portfolio, Rating Activity | |
Defaults in Fitch’s PMM portfolio persisted at a low level in 4Q23 with two issuers defaulting, bringing the year’s total to 15 defaults across 10 issuers on a portfolio of around 275 companies. | |
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For reference, following a sharp increase in defaults across approximately 20 issuers in each of 2020 and 2021 due to the pandemic, defaults were largely subdued in 2022, when eight issuers defaulted.
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Percentage of First Lien Loans with Affected Lender Voting Protection | |
High-Yield Bond Statistics | |
Weekly fund flows source: Lipper | |
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The blue line in the chart is the current dividend yield of the *VanEck BDC Income ETF (currently at 10.8% as of 15 February, 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 7.7% as of 15 February, 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.
The Consumer Price Index (CPI, not seasonally adjusted) stood at 3.1% in January 2024, compared to 3.4% in December 2023 and 6.4% in January 2023. Though inflation has declined, it remains higher than the FED's target (2%). The FED kicked off the year neutral, keeping interest rate unchanged on 31 January quoting still high inflation with March rate cut unlikely. The decline of inflation in 1H24, if the trend continues, will be a crucial factor in determining the possibility of rate cuts which may potentially be at a slower pace than market expectations.
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 February, BIZD dividend yield was at a premium of 315bps to the US High Yield Index, 52bps above the 1-year average of 262bps. 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 625bps as of 15 February, marginally below the 1-year average of 638bps.
*As of 31 January 2024, BIZD’s weighted average market cap stands at USD 4.8bn, with PE ratio of 9.1 and PB of 1, with the entire portfolio holdings in publicly traded BDCs. Click here for top holdings.
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Private Debt Intelligence | |
Fundraising concentration remains stable amid 2023’s challenging market conditions | |
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Despite a difficult 2023, fundraising concentration in private capital markets has remained level for funds and managers in the four years since 2019. Using a Gini co-efficient to demonstrate the distribution of capital across funds shows that fundraising concentration is increasing long-term. However, private capital concentration is impacted by market stresses, such as the dip from the global financial crisis in 2009. Throughout 2023, fundraising was challenged in venture capital and infrastructure, pausing concentration as tougher conditions curtailed larger funds’ ability to successfully raise capital. As private capital matures and GPs raise larger funds, taking a greater share of their core asset class, greater fundraising concentration is likely.
For more, read Preqin’s Insights+ report: The Concentration of Private Capital
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Middle Market Deal Terms at a Glance | |
This publication is a service to our clients and friends. It is designed only to give general information on the market developments actually covered. It is not intended to be a comprehensive summary of recent developments or to suggest parameters for any prospective financing opportunity. | | | | |
