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Frothy Private Credit Market Greases Gears for Buyouts

Frothy Private Credit Market Greases Gears for Buyouts

Stay vigilant amidst positive signs for dealmaking

Matthew Podlesak
June 26, 2024

Capital Pouring into Private Credit is creating competitive lending dynamics and favorable terms for PE PortCos and Deals

Private credit continues to make headlines. Let’s quickly unpack how we got here and where we might be headed.

TLDR:

1. Private Credit is seeing peak capital inflows with the largest fund to date raised by HPS and nearly $2 trillion of AUM raised.

2. The pressure on GPs to deploy Private Credit dry powder is driving competitive pricing and borrower-friendly terms…

3. …which is helping get more PE deals done and dividend recaps to return LP capital.

4. In light of these frothy dynamics: stay vigilant about your exposure to situations where lenders are overly aggressive at the expense of proper credit underwriting.

Today, private credit firm HPS made headlines after raising $14 billion of commitments ($21 billion total with bank loans)

The HPS fund is the latest in a number of “mega” private credit vehicles raised over the last few years.

Source: Financial Times

Private Credit Froth - How Did We Get Here?

Private Credit has been one of the “buzziest” asset classes in recent months.

Private Credit emerged in popularity in the wake of the Fed Rate hikes in early 2022 when traditional bank lenders struggled to underwrite buyout deals.

The interest rate hikes increased the rates of existing floating rate debt, while also increasing the rates at which companies can refinance any debt reaching maturity.

For a number of businesses that were already highly levered, this meant higher interest expenses that reduced free cash flow and reduced interest coverage ratios (a key credit metric).

This pressure on certain highly levered private equity portfolio companies made the traditional lenders for buyout deals - the investment banks - more cautious of refinancing debt for existing PE PortCos and underwriting the debt for new private equity deals.

This lending pullback by the banks created bottlenecks for private equity firms getting new deals done.

This bottleneck created the opportunity for Private Credit that has been aggressively pursued over the last year.

“Private credit firms lend money to all kinds of businesses but they don’t have the same level of oversight as banks do. And it used to be that they didn’t get that much attention.

It was seen as the less glamorous of the two options, investment banking dealing with these kind of big M&A transactions and powerful deals and private credit would sort of pick up the scraps on the bottom.

But as interest rates have risen the past two years – these firms have suddenly found themselves to be the new darlings of the lending world.”

Bloomberg

Source: Bloomberg

How is all this capital pouring into Private Credit impacting the Private Equity space?

The short answer? Tighter spreads and borrower-friendly terms that have been greasing the gears for more buyouts to get done, more dividend recaps to get done (see our post on the resurgence of recaps here).

“Lenders flush with cash and dealing with limited investment opportunities are undercutting each other on pricing and offering unusually borrower-friendly terms as they try to put money to work.”

Bloomberg

Final thoughts:

PE dealmakers are excited to see deals start to get done (or to return capital through recaps)…

…However, its critical for all of us (LPs, GPs, Lenders, Management Teams) to stay vigilant to ensure that the rigorous credit underwriting for PortCos and new deals isn’t compromised amidst a frothy environment.

At Gather Capital, we strive to curate a set of world class alternative investment opportunities, especially within private equity, that enable our clients to invest alongside many of these elite family office limited partners.

We are investing into a wide range of opportunities from:

multi-billion dollar sized funds from blue-chip firms with multi-decade track records of top tier returns…
…to sub-billion dollar sized funds led by highly sought after emerging managers.

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