Private Credit’s Balancing Act

Managers in one of the fastest growing segments of private markets are doing a delicate dance when it comes to chasing deals and maintaining standards for when the next economic downturn comes.

Illustration by II

Illustration by II

Most portfolio managers in the private credit business, a notoriously pessimistic bunch, are feeling optimistic that the pace of new deals will continue to increase this year and the number of defaults will remain low. At the same time, managers are insisting that they are holding the bar high when it comes to important measures of healthy lending, including covenants, or deal terms, according to a Proskauer survey of direct lenders managing $1.3 trillion in assets.

Private credit has been one of the most popular investment choices for allocators, prompting skilled managers to launch their own firms and incumbents to raise new funds — all leading to more dealmakers competing to finance new deals. As a result, investors, while still eager to put money to work in the sector, are watching for dangerous signs of a bubble, lax underwriting standards, and other issues that could threaten future returns.

Stephen Boyko, co-chair of Proskauer’s corporate department and private credit group, described competition for deals as fierce, but he said managers are showing caution. Proskauer’s survey covered what’s driving deal flow and challenges, as well as expectations for interest rates, pricing, and defaults. Earlier this year the law firm also analyzed available data on private credit deal terms.

“The results show that the vast majority of respondents want financial covenants,” Boyko told II. “Direct lenders are drawing the line. They’ll give flexibility when it comes to such things as acquisitions or debt occurrence, but they want the financial covenants. Those are still present.”

According to the survey, 46 percent of respondents from the U.S. said they won’t do deals without a covenant. One-third of those surveyed said that to do a covenant-lite deal they would require a company to have $50 million in earnings or more.


Boyko added that private credit markets have diverged from the syndicated markets, which have let go of financial covenants in many cases. “Direct lenders are buy and hold investors. Covenants give them remedies and a seat at the table,” he said.

The willingness to stand firm on terms comes as managers are flush with cash that needs to go into investments soon. And more money is on its way. Eighty-seven percent of managers are currently raising a private credit fund, according to the survey, and 90 percent say they have plans to open a new fund.

An executive at a private credit firm who declined to be named said 46 percent of survey respondents insisting on covenants still leaves more than half willing to do a deal without solid protections. “The balance between needing to do deals and keeping standards high is not easy to do in practice,” he said. “Everyone will tell you that they’re picky and willing to wait for deals that are priced right. But there are pressures on all sides to get deals done.”

In line with the industry’s success at fundraising, 85 percent of managers expect deal activity to increase; 53 percent of U.S. respondents said the amount of dry powder in the industry is the biggest driver of deals, followed by 26 percent saying vaccinations and re-openings of businesses are the biggest factor.

Another sign of caution in the market is managers’ attitude toward leverage. Fifty-seven percent of managers said they’ll finance deals that have a maximum leverage multiple of 6.5.

Still, 72 percent of U.S. respondents forecasted that deals would be more borrower-friendly in the coming year. Only 6 percent expected a more lender-friendly environment.

Boyko said the Covid downturn from an economic perspective was short lived. It’s been a good time for borrowers ever since. “After lenders vanished in March, April, and May of 2020, the environment snapped back quickly to pre-pandemic levels, including increasingly borrower-friendly terms,” he said.