Global credit funds & CLO's
March 2020
| Issue 221
Published in London & New York.
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Opinion direct lending
Randy Schwimmer
Private credit is not overcrowded — there is four times as much private equity dry powder
Head of capital markets and origination
Churchill Asset Management
March 2020 | Issue 221
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With much negative reporting around private credit, our columnist debunks oft-heard complaints
A sign spotted recently during a winter break with the kids: “There will be a $5 charge for whining.” We want to post that with every negative story we read on private credit; a frequent event as the cycle ages. Accordingly, we offer this guide (a Department of Complaints: Private Credit) for Creditflux readers to help separate fact from fiction.
Complaint 1: “Private credit is crowded”
Investor capital flowing into private credit is dwarfed by bank capacity exiting it. We estimate there’s been a $4.3 trillion cumulative transfer of leveraged loans from regulated entities over the past 25 years. For every $1 of private credit dry powder, there is $4 of private equity dry powder. Yes, private credit managers have been busy fundraising, but most of those dollars are being invested in direct lending opportunities. PE shops look to a limited club of relationship providers with capacity for their credit needs. As these ‘haves’ grow, smaller ‘have-nots’ are being shut out of deal flow. Hence the number of relevant private credit providers is shrinking, not growing.
Complaint 2: “We’re late in the cycle, so loans are now risky”
One of the virtues of private credit is that it is available when public markets are not. Buy-and-hold managers have locked-in capacity, so transactions can be structured without having to time a market take-out. While high leverage and weak covenants are reasons for caution, traditional middle market loans provide a safe haven. They represent a flight to quality. Having a priority security interest in the borrower’s assets and cash flows is the comfort investors should seek in the event of a downturn.
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Complaint 3: “Private credit is the next market bubble”
The leveraged loan market being as large as that for high yield bonds is a question of demand. Similarly, private credit’s popularity is a natural response from issuers and investors, not some unsustainable accident. It is true that private equity valuations are at all-time highs, leading to concerns of overpaying. But this is the result of too much private equity dry powder, not too much private credit. Top prices are being paid for companies in defensive sectors that have track records through business cycles. High valuations are partially offset by supplementing platforms with add-on acquisitions at lower purchase-price multiples. These lower the effective entry multiple, making target returns more achievable. Unlike equities, debt valuations can’t grow to the sky. Getting par for your loan is the norm.
Complaint 4: “Structures are weakening because it’s late in the market cycle”
Financing terms are aggressive, but you could have said that anytime in the past seven years. The middle market began sporting covenant-lite in 2011, barely a year after the great recession.

We view issuer-friendly terms as less a feature of market timing than a result of supply/demand technicals. It’s also true that new managers, with no track record through a downturn have little experience evaluating deals with risky terms.
Complaint 5: “Private credit recoveries will be worse than 2009”
Decades of data show middle market loans have lower defaults and losses, and higher recoveries, than broadly syndicated loans. That is because lenders’ and sponsors’ interests are aligned to maximise enterprise value. Recoveries depend on experienced managers navigating credit risk appropriately. In a downturn, they realise that avoiding cyclical borrowers and selecting defensive sectors greatly improves outcomes.

Finally, what could hurt recoveries are questionable add-backs and adjustments. Leverage that is understated because ebitda is overstated is likely the biggest risk facing private credit today. But partnering with private equity sponsors whose companies have historically succeeded in realising operating synergies will provide protection for credit managers and their investors.
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