RX Analyst’s outlook: A Private Credit Bubble
Hi All,
Interesting thought here, but with the advent of private credit and the amount of money flooding into the space after the reallocation spree from rate hikes, I am not confident in the long term outlook of Private Credit.
Let me explain:
Covenants:
The cov-lite push in 2020 was from practically 0 rate interests from the fed. Debt was so cheap funds essentially funds were trying to get any type of loan they could to provide decent portfolio returns.
Now, there will be another cov-lite era, but this will be defined from the affects of tens if not hundreds of billions of dollars flooding the space from every single crevice of our financial markets. Everyone is competing for the same 3 deals in every tranche, firms are forced to cut back on risk adjusted attitudes in order to deploy dry powder. And alongside Private equity there are only so many good investments one can make in credit.
The fed might hike once more in December, and yes these raised rates will bring higher returns in the short term, the debt is so much riskier and the old portfolio management strategies will struggle to keep up with this higher risk.
Who cares about rate hikes when everyone is offering a PIK
Yes because the solution to enhancing fcf is levering lol
Meh, I think barring GFC style collapse direct lenders will be fine.
1. direct lenders are very friendly, unless it is clear that your debt is severely impaired, they will waive/modify/cure any default which would sink a syndicated deal.
2. interest is all PIKed anyways so won’t cause a cash flow issue
3. unless your fund is super desperate for deployment, most investors avoid cyclical industries like the plague.
so what you gonna do
2020 cov-lite direct lending deals were here for a minute and then passed. They happened but were still considered off-market and granted for the best assets. You will certainly see distress but not enough to turn over the market anytime soon.
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hard to see the direct lenders accept cov-lite terms in this sort of macro and market environment. i split my time between BSL and MM, we just had a tweener in mkt.. the BSL crowd passed on it quickly and the MM crowd stepped in but were adamant on a leverage covenant and tightening every basket by 50-75%.. literally.. also add 75bps to spread. I hate to say it but felt like a pretty efficient, disciplined pocket of the mkt. You're not wrong, just very early IMO.
Almost every mid mkt tech and healthcare direct lending deal in 2020 was done covlite... Large caps were almost exclusively covlite. Hell, industrial deals were getting covlite treatment until 2022 came around
But most of those large cap deals would be outside the scope of direct lenders, in the syndicated market you can (relatively) efficiently transfer for moron CLOs to distressed HF if an issue arises.
Back to turning comments, analyst
Meh, we will see. After being in the market for 15 years, everybody is always preaching dommsday, and those preacher have missed out on alot opportunity since 2008. The flexiblity of private credit is so much higher than a BSL deal. There were a ton of covlite deals in 2020 yes. But alot of "cov-lame" deals as well. Right now, alot of sponsors are getting ahead of what's coming, coming to the table before it's required, especially if liquidity is tight. In the same vein, you see alot of 1L groups organizing preemptively today. Yes rates are much higher and the cash flow profile is much tighter, but dont think we are anywhere near a cataclysmic bubble (everybody always wants to make things black and white).
The material thing I think you're missing: Figuring out which direct lending funds got too aggressive with their NAV facilities when yields were super tight. Once you creep to 1.50x or more of back leverage, it doesn't take many missed interest payments or valuation haircuts to have a margin call. For some of the hyper aggressive health and tech funds that deployed billions over an 18 month span from mid-2020 through 2021 at 1.5x+ back leverage, it doesn't take much to upheave things. And the NAV providers don't play around when it comes to waivers. They typically don't hesitate to make you put more capital up. If I am an LP and I figure out that my capital calls are going to cover margin calls, that is a big red flag.
Only reason PE isn’t blown up is because they don’t need to mark to market.
Damn near half of Clearlake’s portfolio is blown up, and can probably say that for most of the other tech PE firms.
PC will lend to anything because it’s such an oversaturated market and PE barely understands debt/credit and workouts.
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