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Opinion Credit
Private equity titans are still turning to private credit for their financing needs
by Lisa Lee
Lisa Lee
Deputy editor
Creditflux
By raising billions, private credit funds are causing a seismic shift in leveraged finance
Greetings Creditflux readers, this is Lisa Lee. Normally your deputy editor and reporter, I am trying my hand at writing opinion pieces, which is something I used to do in a previous life. That means that here I let go of my journalistic obligation to remain impartial. Instead, you’ll get my opinions — hopefully reasoned, informed and, most importantly, relevant to you. My opinion pieces will always be clearly labelled as such. Now on to the column…
Private credit funds are amassing a huge war chest that’s permanently changing the complexion of the leveraged finance market. The eye-popping fundraise of USD 34bn by Ares Capital Management for US direct lending is just the latest.
True, the headline number is inflated by leverage that Ares intends to put on the fund and by commitments in related vehicles. Still, the USD 15.3bn of equity raised exceeded the initial target of USD 10bn and nearly doubled the amount from the prior generation fund.
Ares isn’t alone. Others are also raising enormous amounts for direct lending, the biggest slice of the USD 1.7tn private credit market. HPS Investment Partners in June closed its latest fundraise with USD 21.2bn of investable capital for direct lending. Goldman Sachs’ asset management arm announced in May it had more than USD 20bn to lend to large companies.
These funds are called direct lending strategies, but they are really leveraged loan funds — loan funds that invest by lending directly to what would be junk-rated companies, were they rated. Sometimes they even sell part of the loan to other credit firms. They just typically don’t buy sub-investment grade loans from bank syndicate desks or from the secondary market, as would a normal leveraged loan fund or CLO.
Darlings of Wall Street
Of course, private credit has already made huge strides. Often in the last couple of years they were the only real source of financing for buyout barons and others looking to raise leveraged debt. As a reward for lending when times were tough and other investors absent or risk averse, private credit funds produced double-digit returns and became one of the hottest plays on Wall Street. Blackstone’s chief Steve Schwarzman even quipped: why would you do anything else?
But the investment banks, the arrangers that structure and sell leveraged loans, and the investors that buy them (mainly CLOs), are back now. And they are hungry and willing to undercut private credit funds on pricing, and nab back market share.
Yet private equity titans are still turning to private credit for their financing needs. Ares reported USD 12.8bn in direct lending in the second quarter when banks were open for business and CLOs were greedily buying loans.
Cutting prices and fees
Faced with resurgent public debt markets, private credit funds are responding by slashing prices and lowering fees. With fund sizes constantly increasing, so does the pressure to compete and do away with the premium that private credit commanded over leveraged loans, in order to nab bigger loans. Then there’s the natural advantage of private credit to offer PIK debt, bigger delayed-draw facilities, and more leverage.
That’s unwelcome news for anyone else hoping for an increased supply of leveraged loans. Only 22% of the USD 300bn institutional loan issuance has been LBO/M&A-related so far this year, which is the lowest level since 2012, according to Citi research. That’s a lot of refinancing activity and little new money.
Even when LBO deal activity returns to form, the leveraged loan market will have to share with private credit. Market watchers predict that private credit could take as much as 30% to 40% of the market. In many ways, the dynamics between the two replicate those between high-yield bonds and syndicated loans after the financial crisis. Back then, the high-yield bond market stalled in size as financial sponsors turned to leveraged loans and sent that market doubling and then tripling in size.
For now, LBOs remain muted. They fell to USD 36bn in the second quarter of this year from USD 45bn in the first quarter of 2024, according to Citi. While investment bankers were promising deals to come, there was little real pipeline of deals. And since market volatility is a deal dampener, the rest of the year won’t test whether financing deals will go to private credit or syndicated leveraged loans.
