A dirty little secret in a $1.2 trillion world of credit is getting exposed as the Wall Street rout deepens: Private debt is now the cheaper financing option for big-ticket leveraged borrowers than the ailing public market -- upending industry norms.
As banks get pummeled by risk aversion and sinking asset values, direct lenders are lavishing risky companies and private-equity firms with capital at rates below what’s available in the volatility-lashed high yield and syndicated loan market.
These asset managers are so desperate to unleash all the billions amassed in the low-yield era that they’re increasingly putting up with lower returns than their risk-averse peers in other parts of the credit world are willing to stomach. As traditional lenders beat a retreat, the bonanza is helping power leveraged buyouts with deals including The Access Group, Davies Group, Ivirma Group and Zendesk.
“We have seen a few cases in which private credit firms swooped in and participated heavily in deals that otherwise would have been distributed -- or even were in the process of being distributed -- solely to the public markets at the same contractual terms and even tighter pricing than the syndicated markets were willing to provide,” said Scott Macklin, director of leveraged loans at AllianceBernstein.
With the Federal Reserve rushing to tighten policy in a bid to tame inflation at four-decade highs, the average yield on US junk bonds has roughly doubled this year in an historic selloff as the primary market has been all but frozen.
While unsecured debt for the riskiest part of LBOs can come with double-digit yields, sponsors have been able tap into the private-lending boom to secure all-in yields below 9%.
Likewise in Europe, premiums for direct loans remain low and have defied the broader repricing in global markets, according to four of the region’s biggest private credit providers and advisers, who declined to be identified because they weren’t authorized to speak publicly.
All this is potentially bad news for private investors who were promised higher returns than bank loans offer, in exchange for tying up capital for as long as 10 years -- known as the illiquidity premium.
Shadow lenders include the likes of Blackstone Inc., Apollo Global Management Inc., Blue Owl Capital and HPS Investment Partners. Industry players say they are making good on a promise to provide financing in volatile economic climates, at rates that are both affordable for borrowers and attractive for its investors. In this view, premiums in the public market look dislocated relative to fundamentals, with strong issuers getting punished by an indiscriminate selloff.
Meanwhile banks are struggling to sell the buyout debt on their books -- and they’re charging so much for new deals that they are effectively undercutting new business opportunities. Just this week Walgreens Boots Alliance Inc. scrapped its potential sale of the Boots drugstore chain in the UK, in part because of the rising cost of raising capital.
In their zeal to win market share over the long haul -- something investment bankers may struggle to win back -- private lenders have been willing to undercut traditional players.
While AllianceBernstein last year touted a more than 3% premium over the public market for mid-market private lending, increased competition between direct lenders saw that dwindle to an estimated 1.7% in March 2022, according to the US-focused Cliffwater Direct Lending Index.