It’s easy to speculate about the health of the private credit market. That’s because it’s private and therefore opaque: Details of the underlying deals in alternative credit funds aren’t public, barring a small portion in listed business development companies.
However, according to proprietary data collected by law firm Proskauer, the market is fairly healthy based on historical measures, including covenants, leverage, and default rates.
In 2019, Proskauer found that 3 percent of its approximately 525 active deals were in default, meaning that a company was in payment default, bankruptcy, or in breach of a covenant for more than 30 days. This 3 percent default rate is in line with the historical default rate of 2.93 percent on leveraged loans recorded by Standard & Poor’s LCD.
“If a default doesn’t go away in 30 days, then that’s a good indication that something is going on with that company,” said Stephen Boyko, a partner at Proskauer and co-head of its private credit and finance groups.
Although Proskauer’s data doesn’t cover the entire private credit market, the law firm closed $57.9 billion in private credit deals across the U.S. and Europe last year and currently represents more than 75 of the largest direct lenders. For context, asset managers gathered about $107 billion for direct lending funds in 2019, according to Preqin. Asset management professionals contacted for this story say the law firm’s information serves as a good proxy for what what’s going on in the overall market.
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One of the concerns about the private credit market is how quickly it has grown, and how well asset managers can put that amount of money to work. Last year, Proskauer saw a 23 percent increase in the number of deals it worked on, accompanied by a 38 percent rise in total dollar value. Boyko said asset managers are scouring the market for large and small deals and are putting money to work in a broad array of sectors in the economy. About 57 percent of deals were in healthcare, software and technology, and business services. But Boyko said there are 200,000 middle market companies in the U.S. with revenue between $10 million and $1 billion that private credit managers could target for deals.
“While there’s been spectacular growth, it’s also a simple shift of who is doing the business,” he said. “In 2008, banks did 85 percent of all leveraged loans; now banks are less than 15 percent. There is a thirst for capital in the market, and the direct lenders are filling the void left by the banks.”
Leverage put on middle market companies is increasing, but Proskauer’s data shows that on average, leverage is 5.4 times for U.S. deals. That’s less than the average for large syndicated deals from the banks, which typically have leverage of 6x or 7x. Still, add backs to earnings before interest, taxes, depreciation, and amortization have continued to grow, resulting in significantly higher actual leverage.
In the law firm’s sample, 90 percent of deals had covenants, 97 percent were secured, and 86 percent were first lien loans.
“They might be looser than historically, maybe more add backs for instance, but they have covenants,” Boyko said. “We are 12 years into the expansion, so terms are getting looser and more borrower favorable. But if you step back, there is security on everything.”
The lawyer added that private credit deals as a group are “more highly structured, lower levered, and more heavily diligence’d.”
According to Boyko, some of the handwringing around private credit may emanate from concerns outside the asset class.
“There is a focus on the fact that a lot of money has been raised. There are bigger and bigger deals. This week alone there were two deals announced that were over $1 billion,” he said. “The trend toward covenant lite in the syndicated market makes people mistakenly believe that it’s also happening in private credit.”