Private credit funds are willing to grind down margins and crank up leverage to win business over their liquid peers and stay competitive with the broadly syndicated markets as deal flow has remained muted.
Credit spreads are among the tightest they’ve ever been for the industry’s best borrowers, with private loans recently pricing as low as 4.5 percentage points over the Secured Overnight Financing Rate in the U.S., and 4.75 percentage points over Euribor in Europe. Meanwhile, hopes that the Trump administration would bring a renewal in mergers and acquisitions haven’t yet materialized.
“Spreads are in across the board this past year as private credit managers continue to replace bank financing in increasing scale, especially for higher leveraged, larger credits,” Matt Douglass, chief executive of PGIM Private Capital, told Bloomberg News.
Take the financing for Clearlake Capital Group’s purchase of Modernizing Medicine this month. Private credit funds led by Ares Management agreed to provide $2.2 billion of debt to support the acquisition. The deal priced at 4.75 percentage points over the U.S. benchmark rate, while leverage was between eight and 10 times, people with knowledge of the matter said.
Private credit deals generally offer a premium on spread for illiquidity. But the availability of capital has driven down spreads from peak underwriting times. Average direct lending spreads were as high as 675 basis points over the Secured Overnight Finance Rate in March of 2023, according to a J.P. Morgan report from February. This January, according to J.P. Morgan’s and KBRA DLD’s data, average spreads were 500 basis points over the Secured Overnight Financing Rate.
All options are on the table for private credit lenders. Often, they’re willing to add more leverage, offer payment-in-kind toggles to allow borrowers to defer cash interest payments and accept dividend recapitalizations.
Leverage can stretch to eight times debt-to-earnings, and for some deals, above 10. Terms have loosened, too, with more lenders accepting a lack of maintenance covenants and generous definitions of earnings before interest, taxes, depreciation and amortization.
“Deal flow is improving, but it does, admittedly, remain below normal,” said Bill Sacher, the head of private credit at Adams Street Partners. “There is a supply and demand imbalance and as a result when you are trying not to lose the asset, that creates an elevated level of competition.”
As spreads have compressed, companies that scored debt in peak-rate markets have been eager to bring down their cost of capital. Up until recently, syndicated loan markets have been wide open, offering cheaper pricing and taking back credits once snatched by private debt players.
Deals for companies including Finastra Group Holdings, Kaseya and Avalara once signaled the strength and permanence of the private credit industry. But these firms are now looking to the banks to refinance their loans in the traded debt markets.
Denise Gibson, U.K. managing partner at law firm A&O Shearman, told Bloomberg News that an attractive company that’s focused on driving down its cost of debt would take the broadly syndicated route over the private credit option.
But “with the market uncertainties that we are all facing we are most certainly in a world where sponsors are keeping their trusted private debt funds on speed dial,” she said.
