Private Credit Viewpoints in 2024

Executive Summary:

• The Broadly Syndicated Loan (‘BSL’) market rallied at the beginning of 2024, creating pressure on credit spreads. 
• Amidst a muted LBO backdrop, private credit deal activity has remained elevated, driven largely by incremental term loans and a growing maturity wall. 
• The default cycle, which investors feared, has been relatively benign thus far and lenders will maintain pricing levers to create interest relief for select borrowers.  
• Looking ahead, we believe that private credit is favorably positioned to continue delivering consistent performance and yield to investors amidst an evolving landscape.

Syndicated Bank Loan Market  

2024 opened with an incredible BSL rally in the U.S., dominated by repricing and refinancing activity and a sprinkling of dividend recapitalizations. By the numbers, U.S. syndicated loan volume in Q1 2024 reached $162.5 billion, eclipsing Q1 2023 volume by 125%.¹ In Europe, Q1 2024 volume was up 159% versus the prior year with $30 billion in syndicated loan volume.² 

Implications of the BSL Market Reopening for Private Credit  

The uptick in BSL activity for deals primarily in the B to BB range has introduced some spread compression for comparable private credit deals. Middle-market first lien deals have experienced +100bps of spread tightening and more borrower-friendly terms such as incremental debt allowances and grid-based pricing have crept back into credit agreements. First lien private credit transactions that saw pricing above S + 600 in 2023 are now pricing in the S + 475 – 550 range. However, despite credit spreads tightening, all-in yields remain attractive due to an elevated interest rate environment and the private markets are still enjoying a yield premium of +170bps relative to the BSL market.   

Additionally, while the Fed is expected to cut rates, the forward SOFR curve forecasts one-month and three-month SOFR figures will remain above 4.5% in 2024 and above 3.5% beyond that, suggesting that yields should remain higher for longer. Last but not least, capital structure discipline persists in private credit, despite a reopening of the bank market. Private credit structures continue to be defined by lower loan-to-values with healthy equity cushions. Not too shabby.  

Drivers of Private Credit Deal Flow Amidst a Muted LBO Backdrop  

Recent activity levels have largely been dominated by two transaction types for private credit lenders. The first is incremental term loan facilities. These incremental loans are oriented to private equity owned platform businesses undergoing buy-and-build strategies, where the incremental term loans are typically used to support smaller add-on acquisitions. These facilities often have a delayed draw feature, which is designed to provide committed and unfunded borrowing capacity for a period of approximately 12 to 18 months.  

The second transaction type is refinancing, driven by either maturity walls or changes in company capital structure needs. Holdco Paid-in-Kind (PIK) notes have been a commonly used tool to support refinancing activity, particularly where lenders have been unwilling to replace the entirety of the existing debt. In a simple example where a company is seeking to refinance 6.0x of debt, they might be able to get 5.0x of unitranche debt and bridge the remaining 1.0x with Holdco PIK notes. Given the interest on the Holdco note is deferred, the interest burden on the company is lower.  

Default Outlook 

Despite investor unease as rates began their rapid rise, the default environment has been relatively benign thus far. The default rate by amount outstanding in the Morningstar LSTA U.S. Leveraged Loan Index was 1.14% in March, down from 1.41% in February. In December 2023, Fitch Ratings forecast 2024 leverage loan default rates of 3.5 - 4% and receding to 2 - 3% by 2025. 

Our view is that highly levered companies in cyclical sectors will be most affected. For example, 2021 vintage deals levered >6.0x on an adjusted EBITDA basis, which unadjusted could be >8.0x levered (off of true cash flow), may experience more pain particularly as those deals were structured in a near-zero interest rate environment.  

While higher-for-longer interest rates will pressure certain borrowers, we believe that private credit is generally well-positioned. Structurally, transactions have continued to see strong equity contributions and lower loan-to-values as a percentage of enterprise value. Senior secured deals in particular are nicely positioned due to their seniority in the capital structure and the prevalence of financial maintenance covenants, especially for deals done in 2022 and 2023.  

Unlike broadly syndicated loans that trade hands, private credit tends to be more long-term in nature. As a result, we expect lenders and borrowers to work more closely in preventing defaults. One example of how lenders can accommodate borrowers is by converting a portion of a company’s interest obligation to PIK to create some cash flow relief. In exchange, lenders may earn fees or a higher all-in interest rate. 

Looking Ahead 

While the bid-ask spread still looms for equity investors, we are optimistic that credit deal flow will continue to be robust in 2024, largely driven by the demand for incremental term loan facilities, upcoming debt maturities and recapitalizations. Anecdotally, during Q1 2024, Hamilton Lane saw nearly $3.1 billion in deal flow, which surpassed Q1 2023 volume by 40% (2023 was a record year for HL) and we don't see any signs of that slowing down. 

HL Credit Deal Flow
$mm

And while private credit deal activity is not dependent on a rebound in LBO volume as we have seen over the last two years, we are cautiously optimistic that activity levels will pick up this year for a couple reasons. First, LPs are demanding liquidity. Distributions as a percentage of NAV are down relative to the long-term private markets average of 24% and hold periods are getting longer for buyout deals.  

Annual Private Equity and Credit Distributions

Holding Period of Exited Buyout Deals
% of Deal Count by Year of Exit

Secondly, borrowing costs are slowly coming down as capital markets activity has picked up and investors have improved clarity on macroeconomic conditions and Fed policy. 

Overall, we believe private credit is favorably positioned to continue delivering consistent performance and yield to investors amidst an evolving landscape. In a higher-for-longer interest rate environment, attractive yields will continue to be a driver of investor interest in the asset class. While rates are expected to soften, ultimately, the economy will dictate the velocity and quantum of Fed actions. Any weakening of the economy might cause the Fed to reduce rates earlier and, if inflation proves more persistent, the Fed might be slower to bring rates down. Regardless, private credit yields should remain elevated.