Funds exploiting weak creditor protections have already wreaked havoc in the public markets. That’s making private lenders think twice about who they’ll work with on larger deals, according to Ana Arsov, global head of private credit at Moody’s Ratings.
“It’s almost like a marriage agreement and the divorce can be very expensive,” said Arsov in the latest Credit Edge podcast from Bloomberg Intelligence.
As too much money chases too few deals, covenants are weakening. Companies running into trouble have found ways to get around some of them, prompting so-called creditor-on-creditor violence, which isn’t yet proliferating across private markets.
“People are wary and watchful — more than ever,” said Arsov. Funds are trying to “distinguish which partners are civilized in this market, which are not,” she added.
It’s a growing dilemma as the $1.7 trillion private credit market has swiftly evolved from a bi-lateral market, involving a single lender and borrower, to almost three institutions on average now putting up cash for a transaction, according to Federal Reserve data. For deals over $1 billion, it’s become more common to see six to eight lenders, Arsov said.
When analyzing balance sheets of private lenders for risk, Moody’s is particularly focused on deals signed in 2021, when interest rates were near zero. Arsov also noted a general decline this year in private credit market spreads and terms as new money piled in.
According to Moody’s analysis, private loan covenant quality and deal pricing is holding up on deals below $300 million in size, but protections on larger transactions are weakening, tracking a deterioration seen in the broadly-syndicated loan market. “That’s what worries us particularly about this exuberance of 2024,” Arsov said.
Private credit also faces rising refinancing risks as more deals are amended or loans are repaid with new debt. Plus there’s a growing risk of lenders over-extending themselves, Arsov says.
“It’s going to be very important to get more transparency from the banks about is there some kind of synthetic leverage, additional leverage coming to this market,” she says. “There’s still lots in the dark.”
Rapid expansion of the asset class, which has attracted a significant number of new entrants, is also a threat.
“Everybody wants to be Apollo,” says Arsov, referring to Apollo Global Management Inc., a major private debt market participant. “There’s limited talent, I would say — more than limited capital — these days. So for sure, investors should be watching where they place their money.”
However, trouble in private credit isn’t expected to penetrate into financial markets more broadly.
“It just doesn’t seem like the risk-transmission mechanism is nearly as potent in the way that that private credit is structured today as it has been in maybe some other areas that have caused systemic problems in the past,” said Bloomberg Intelligence senior credit analyst David Havens.
This article was provided by Bloomberg News.