Fast Times At Private Credit High
Stuffing some dorks into lockers
Whenever I do AMA’s, people are always asking me to dish on different lev fin / private credit providers. Think the blog is the best environment for this. Some would say its hard to compare different private credit funds because the industry has become commoditized and everyone does the same thing. Indeed, the asset class’s 15 minutes of fame has occurred instead over the past decade, as a rapid influx of capital over that period coincided (and may have been a result of) an era of loosened monetary policy.
(Tangent: RIP to day in the life tik tok’s from 25 year old Google product managers, cheap Uber’s subsidized by VC money, and lenient WFH policies. Did you guys ever watch that show Westworld? 1st season was tight and it fell off a cliff after that. But in it, people struggle with what is reality vs. a fantasy simulation. This is kind of what it feels like seeing interest rates rise. Like its hard to tell what portions of the economy and business trends that popped up over the past ~5-7 years have any real staying power.)
The increase in private credit AUM has resulted in more aggressive deals and more competition, which has subsequently led to lenders having to more or less fall in line with each other. Oh you thought of some creative financing structure at 4.5x / 6.25x leverage where you commit to the entire first lien, and leverage deep LP relations to fill out the second lien for cheap? Well too bad, because Owl Rock (or Blue Owl? You can’t just subtly switch your name like that and not expect us to be confused) just gave them a 7x unitranche. You have 24 hours to decide whether you want to be a small participant in their deal at a 1% OID. Fuck you.
People have speculated this commoditization will be sustained. I actually disagree. I think this tough rate financing market is going to result in lenders and sponsors showing their true colors. I think the real winners in private credit will be the ones who avoid nuclear losses and have enough liquidity/scale to take losses while continuing to deploy new dollars. I could see a lot of large asset managers / banks retreating out of the space when things start to get rocky. There are going to be some tough conversations when some previously solid credits get distressed, and the sandbox that everyone has been playing nice in the past decade is going to get a couple needles tossed into it. Sponsors are going to be more likely to support portco’s where they have strong lending relationships that they can’t really afford to lose, and might be fine flipping the keys (and the middle finger) to rando’s who gave them the leverage they wanted three years ago.
In recent years, investors had been thinking with their dick, deploying AUM as quickly as possible so they can raise more. The increase in rates was the equivalent of an STD scare or getting caught cheating. They’re now done with the fuck boy phase and are thinking with their brain. They are looking for a good girl with a conservative (and high yielding capital structure). The real “take home to LP’s” type ya know?
As someone who started their career well after the ’08 recession, its been kind of a revelation for me over the past ~six months to see how rising rates impact private credit funds. It’s a double edge sword – given most PC funds are both lending and borrowing at variable rate, rising rates leads to higher dollar profits (with flat to slightly higher margins depending on a PC fund’s cap structure). But obviously higher rates increases portco interest expense and the chances of a default. So you’re threading the needle on profit and not taking losses. My reckless speculation is we don’t start seeing material losses until late 2023 / 2024 given 4%+ SOFR rates have only been in effect since 3Q22.
Without further ado, lets break down the private credit competitive landscape. But instead of a typical competitive landscape chart with all the circles (where miraculously the target Company has the best rankings of each category), I’ll be grouping everyone into different high school cliches to match the pettiness of this industry.
(Please note these are just my 100% anecdotal opinions)
The Rich Kids
Players: Megafunds such as Carlyle, KKR, Apollo, Bain, Blackstone, Harvest, Thoma Bravo, Vista
Description: These are the kids whose parents (private equity funds who have been around for ~30 years) drop them off in a G-Wagon and have been dressing them in vineyard vines and seersucker since they came out the womb. These parents still have a vibrant social life which gets in the way of giving their kids attention, so the kid’s personalities are sort of duds. For real though, its interesting to me that the private credit arm of these megafunds haven’t made more inroads. Best guess is they are newer and don’t have as long of a track record. They have plenty of AUM to deploy, but seem to be choosier about opportunities. This is likely due to many sponsors wanting to avoid working with competitors, so they may be more prevalent on the non-sponsored side but I can’t say for sure. In Classic Rich Kids fashion, this lack of deal flow doesn’t sit too well with them so some of them formed a group (I forget the exact name of it, but I promise it exists) based on a handshake agreement to show each other’s debt funds their PE side deals.
The Sluts
Players: Ares, Blackstone, Golub, Owl Rock, Antares, Goldman Sachs
Description: These are the firms with some of the strongest sponsor relationships. They are some of the first calls investment banks call for leverage reads. I call them sluts because they are always down to fuck (i.e. do deals). These guys are always busting at the seam to the physically most aggressive deal possible (a great example is the Coltiviti deal recently, where top tier sponsors were able to get 50% PIK interest for the first couple years on a deal given strong direct lending relationships). These guys are huge in the unitranche market as well. Goldman is the oddball inclusion here given they are the Lebron James of IB, but their lending presence is like Dame Lillard (vet, calm, underrated). Just shows how strong they are across the board.
For the noobs, unitranche loans are a single tranche loan that blend a 1L and 2L rate and leverage (so if a deal would be 4x 1L / 2x 2L for a total of 6x, you would take the weighted average of the rate and just do one tranche. This allows for private credit to raise and deploy huge dollars and achieve a yield that is in their wheelhouse. They can also close deals much quicker than the syndicated market, which the sponsor loves. Since rates went up and the economy softened, unitranche loans are significantly less prevalent and 2L/unsecured mezz is back in vogue. I remember when everyone in 2015-2016 acted like a unitranche loan was the most innovative creation since the iPhone, but I am starting to wonder if it was just the product of low rates and loose monetary policy. It does have a solid value prop though, and will come back over time. But 2L/mezz structure’s aren’t ever going extinct.
The Chicago Kids:
Players: NXT, Twin Brook, Monroe, Apogem (fka Madison), Maranon, Prudential
Description: For some reason, private credit has strong roots in Chicago. Tbh, being second fiddle to NYC while private credit is kinda like PE’s younger brother makes for an apt comparison. Anyways, there are enough pure play Chicago players that it made sense to group them together. These are a bunch of good people that try to hide their Midwestern accent as much as possible. You’ll meet a lot of people named Emily from Indiana University, or Dan from Marquette (I’m convinced 75% of dudes that live in Chicago are named Dan.) Specifically, NXT, Twin Brook, and Apogem are very similar: they mainly just do lower yielding first lien debt, they’re pretty conservative (with their leverage reads not their political views), and they’re usually on the right (i.e. not leading deals, also not political views lol) to the Sluts mentioned above. This means they love to bitch and moan about every term the Slut presents during negotiations. This is until the Slut calls the sponsor to moan and bitch about the Chicago Kid moaning and bitching (“mom, come pick me up, the joint right arranger is annoying me!”), so the sponsor calls the Chicago Kid to moan/bitch about the whole situation. Then the Chicago Kid falls in line. Tale as old as time.
The Nerds:
Players: HPS, and probably a bunch of small firms that don’t get any PR
Description: This is mainly to call out HPS as being one of the more unique players in the space. They are known as being the most “cerebral” given they are less involved in crazy auction processes with 10+ sponsors getting the most aggressive terms on the most aggressive timeline. Instead, they do a lot of hairier, high yielding stuff non-sponsored deals. (Tangent: You know that Lion King meme (see below for a version I’ve made) where Simba asks Mufasa “what’s that shadowy area over there?” To me, the shadowy area is non-sponsored deals. While I’m not saying PE funds are the operating geniuses they often claim to be, they are at least good as fuck at cutting costs when needed and holding management accountable to hitting budget. They also can help provide equity injections if the business struggles.”) HPS is one of the few players (that I’m aware of) that is willing to deal with these kind of deals at scale, and they are handsomely rewarded for it. Not exactly sure what kind of extra premium they get, but its pretty sizable. Partially, this is because there is a shit ton less competition in this weird sub-segment of the market. And also, given there isn’t a PE fund to help you with diligence and scrub some dirty ass interim reporting numbers, these are doing some heavy diligence lifting (often times near the amount a PE guy might do). Sounds interesting but painful. That all being said, they do a bunch of traditional sponsored/distressed stuff too.
The Bad Boys
Players: Marblegate, Cerberus, Oaktree, SilverPoint, Black Diamond, and like 50+ others
Description: You know how every successful ecosystem has to have balances to prevent the apex predator from getting too strong? Well imagine PE funds are lions, lenders are helpless gazelle that they gobble up, and The Bad Boys (distressed debt funds) are deadly mosquitos that keep the lion population in check. Mosquito is the correct comparison because they are annoying as fuck. These guy’s jobs are a wild hybrid of law and finance. Not to toot their horn too much, but I do believe it is the most complex field of finance. You have to know the docs cold and figure out how to catch the falling knife that is the shitco’s you’re investing in. Then once you’re in the deal, you enter a mortal combat style battle against sponsors that are just are twisted and evil. The thing that kind of gets me with these guys is despite the effort and knowledge required, they don’t make anymore than a PE or IB guy. In fact, they often times make less. Part of it is because this is a very high risk/reward field where you can take huge losses. Also, there limited good opportunities so everyone crowds into them. Also, these bastards don’t need your silly currency, they get Paid In Smugness (PIS). To them, getting to tell everyone you are a distressed debt investoooooor who is on every DQ list. For the noobs, a DQ list is a list disqualified lenders who are such dickheads to borrowers that they are banned from participating in the credit facility. It’s the white collar equivalent of a wanted poster back from the wild west saloon days. So this kind of badassery is worth the extra hundred thousand bucks they’re forgoing.
The Other Guys
Players: Barings, Crescent, Alliance Bernstein, Churchill, Benefit Street, Crescent
Description: Let me first start off by Other Guys is a great movie and probably one of the last good comedies ever made. The “Who wants Arnie Palmies!?” line never fails to get a laugh out of me. Also, it randomly has a deep side plot related to white collar fraud lmao. But anyways, this crew is sort of just other large direct lenders who I can’t place in a more direct theme. They all seem to do a fair amount of deals but never rock the boat with a huge mandate or super controversial deal. They all do fairly similar deals (1L and unitranche, although I know Churchill/Benefit Street/Crescent do some junior debt stuff). It also seems like they have solid work life balance given maybe they suck slightly less sponsor dick than the Sluts (sidenote: High Yield Harry had a good tweet the other day basically pointing out that unless you get stuck in a weird sweatshop, credit work/life balance is undefeated. Making $500k by the time you’re 30 and close to a million by the time you retire to work 40-60 hours a week is pretty awesome.) Still plenty of dick sucking though, don’t get it twisted. Benefit Street and Crescent are definitely a little more yield focused, while Barings is the Charlotte cousin of the Chicago kids.
The Normies
Players: Asset managers like Invesco, BlackRock, etc. as well as bunch of random small funds
Description: I call these the Normies because they’re kinda just there and incredibly average. They’re the kid in high school that got a 3.3 GPA, had 6-7 friends, played a sport but warmed the bench, went to prom with a solid 5/10, got drunk for the first time senior year, etc. If DD guys are Slytherins, these guys are Hufflepuffs. They are participating in similar debt facilities, but they are the ones selling to distressed to GTFO out of underperforming companies and cut their losses. These are generally docile creatures who look to create a diversified portfolio of loans through taking small holds across a bunch of deals. Because their holds are small, they are what we call in the biz “term takers”. This means they aren’t going to push back on the credit agreement, they relay on institutions with much larger positions to do that. This isn’t a bad gig but gets pretty boring over time because you aren’t doing much of an underwrite, focusing more on relative value and picking industries as a whole that you like. I will say, these guys sometimes act a little big for their britches. They will have like a $20MM hold in a $5B facility and will reach out to the agent with a list of 10 questions that they want the management team to answer. Harry Potter and the Audacity of this Bitch. The agent bank usually initiates Ghost Protocol in these situations.
Ok that was a long one. I can hear that goofy music that comes on at the Oscars where they play you off the stage. Gonna go ice my fingers. Thanks for reading!
This was a masterpiece