Direct Lenders Are Poised to Pounce If Credit Volatility Extends

(Bloomberg) -- Direct lenders are preparing to pounce on opportunities in credit markets after turbulence that deterred other investors.

The high-yield bond and leveraged-loan markets have been rattled by trade jitters and fears of slowing global growth in August, with a raft of deals scrapped and continued outflows from funds that buy the debt.

“This potentially creates pockets of opportunity for private credit,” said Drew Schardt, head of credit at private market investor Hamilton Lane. “The heightened volatility that we’re seeing now creates a bit of a borrower-lender disconnect, and the markets are trying to decide whether what we’re seeing right now is just fleeting volatility or indicative of a fundamental deterioration.”

Sponsors are viewing non-bank lenders as “a safe haven -- a credit solution that doesn’t depend on the vagaries of the loan syndication market,” said Randy Schwimmer, head of origination and capital markets at Churchill Asset Management.

“Money moving in and out of retail loan funds is not what drives the private debt market,” Schwimmer said. “It’s instead driven by private equity fundraising. That’s the fuel that feeds the financing pipeline for direct lenders. It remains plentiful and we see no signs of that abating.”

August Deals

Private credit investors are not without concerns, a major one being that the business cycle is about to turn. They’re navigating lower interest rates and slowing global growth, while the economy remains strong with low unemployment and a decent performance from borrowers.

“Generally, folks want to lean-in to more defensive positions in the current environment,” Hamilton Lane’s Schardt said. “Private lenders are exercising caution in terms of how they’re structuring their deals, in terms of a willingness to move up the capital structure and a desire to shorten duration in some cases.”

In some corners of private credit, spreads have even contracted as investors pile in to higher quality names, according to Ted Goldthorpe, head of credit at BC Partners. Unitranche debt for a solid borrower with strong sponsors that may have been priced at 575 to 600 basis points above the Libor benchmark a year ago is now in the 525 to 550 basis-point range, he said.

Pricing for first-lien loans has held steady at around 400 to 450 basis points and second liens around 750 to 850 basis points above Libor, Goldthorpe said. Though falling Libor could be a headwind to the asset class, returns in middle market debt could still hit 7% to 9%, he said.

“I still think middle market lending is still good relative value compared to other asset classes.” he said.

To contact the reporter on this story: Kelsey Butler in New York at kbutler55@bloomberg.net

To contact the editors responsible for this story: Natalie Harrison at nharrison73@bloomberg.net, Sally Bakewell, Dawn McCarty

©2019 Bloomberg L.P.