Private debt funds have a $500 billion conundrum
Private credit’s success is creating a $500 billion headache: finding a home for all the money that’s been raised.
Fund managers potentially lost out on more than $7 billion of lending deals in less than 48 hours this week, highlighting the difficulties they face in allocating billions of dollars of dry powder following the industry’s rapid expansion.
A dearth of quality lending opportunities, a revival of competition from banks and a slew of new entrants have resulted in a scarcity of suitable deals to back. That could trigger a race to the bottom between debt funds and banks and result in systemic risks, Moody’s Investors Service warned last month.
Private credit firms, which manage around $1.6 trillion, are already giving up investor protections to secure larger refinancings, leaving them more vulnerable to higher losses if borrowers default. Adding to the problems, the funds have investment periods of three to five years, creating a possibility that providers will sign up to lower quality loans to get money out the door after promising high returns to investors.
“Yield was impressive earlier this year, but this is a fast-moving market and those higher prices are going to get competed out pretty quickly,” said Daniel Bird, the founder of Thornwood Hill LLP, an investor that works on behalf of family offices.
The $7 billion plus of deals that risk falling apart this part week show just how hard it is to get deals done. A consortium led by Permira and Blackstone Inc. reportedly reconsidered its pursuit of the European online classifieds company Adevinta ASA, which lenders had hoped to back with more than £3.5 billion ($4.3 billion) of financing. A day later, it was reported that Advent had pulled the sale of CCC Intelligent Solutions Holdings. Private credit funds had offered at least $3 billion of debt to bidders in that deal.
Even as activity in the broadly syndicated market recedes again, new providers are entering the private credit market. Pictet Asset Management and Fidelity International have opened funds and a slew of banks and asset managers are planning to as well.
Still, private credit continues to gain market share over banks and syndications and pricing remains attractive, Ares Capital Corp. Chief Executive Officer Kipp deVeer told analysts in recent days.
The scrum for the best deals follows the collapse in the number of mergers and acquisitions after interest rates rose. Muted supply of new debt is now contributing to spreads narrowing, which could weigh on returns for private lenders and spur them to take more risk. The expectation was that debt for the Adevinta buyout would be priced at 575 basis points over Euribor, a significant tightening from the 650 to 675 basis points over the benchmark that’s been the norm over the past two years.
When spreads narrow, investors often have little choice but to keep putting money to work.
“The last thing you want to do as a manager is stop deploying,” said Floris Hovingh, managing director at Perella Weinberg Partners. “There’s negative sentiment in the market around it and it can make fundraising difficult. It starts a negative spiral that a direct lender should avoid.”
