‘Reprice — or else’ trend sweeps private credit

Spreads on new M&A transactions in the private credit and syndicated loan segments are converging, highlighting how the two markets are competing to win deals in today’s hotly contested leveraged finance arena.

Traditionally, spreads on private credit loans have featured a premium of 100-200 bps, at a minimum, compared to those on syndicated loans. Private credit loan borrowers agreed to pay this premium in exchange for features such as certainty of close at an agreed-upon spread, or not having to obtain ratings.

With M&A and buyout activity relatively scarce, due to still-high base rates, and with investor appetite for risk increasing, loan supply is running behind investor demand by a record amount. As a result, credit spreads are compressing.

Indeed, with the two markets in hot pursuit of that limited deal flow, the pricing premium on private credit loans has declined significantly, according to LCD.

In 2023, PE-backed borrowers rated B-minus saw spreads ranging from 350-to-525 bps over Sofr on broadly syndicated deals supporting buyouts and other types of M&A deals. For private credit, that range was much higher, 525-to-775 bps, based on LCD News coverage. Looking at the data another way, the difference between the midpoint of these ranges was 212.5 bps.

So far in 2024, BSL spreads have stayed within a tighter range of 400-to-500 bps vs. 475-to-625 bps for direct lending transactions. The gap between the midpoint of these ranges has narrowed to 100 bps. Private credit lenders are displaying a willingness to forgo some or all of that spread premium.

Failing to do this could well have severe consequences, particularly when activity in lucrative deals, such as buyouts and M&A, is lacking. The market already has seen a notable shift in momentum from private credit in 2023’s second half to the syndicated loan segment in 2024. More than $13 billion of loans provided by direct lenders have been refinanced with a broadly syndicated transaction so far this year.

Another indication of increased risk appetite from investors: In the first quarter of the year, the syndicated loan segment reopened in a big way for lower-rated issuers to reprice deals originated before credit spreads narrowed, part of a broader wave of opportunistic issuance.

Prior to Q1 2024, riskier, B-minus rated issuers had been largely unable to opportunistically issue in the syndicated market.

Dash to slash
In the current market, lenders are receiving calls from private equity sponsors with requests to slash pricing by 100 bps, with few administrative obstacles, sources say. That means one advantage that private credit lenders have long touted — that a sole lender or small lender group is easier to work with — can be seen as a double-edged sword, as it’s relatively simple for a loan issuer or sponsor to request a price cut to a single issuer or small club.

Big savings
In the first quarter, borrowers were able to move from the private credit market into the syndicated market for cost savings of more than 300 bps on second-lien or unitranche loans, sources say. Now, LCD data show that private credit lenders are responding in a different way to market pressures — by offering loans at spreads in line with or closer to with what’s on offer in the syndicated loan market.

And looking to the near-term, the repricing wave that occurred in the first quarter of 2024 appears to be continuing.

Earnings for business development companies, which start in earnest tomorrow, are bound to shed further light on any “reprice — or else” trend.

BDC portfolio data shows where potential opportunities lie for future refinancing.

An analysis of spread distributions in BDCs shows that roughly 40% of first-lien term loans and unitranches held by BDCs in Q4 2023 had spreads in the S+600 area (between 600 and 699), while 27% were in the S+700 area, LCD data show.