Private Credit Deals Exclude Wall Street from the Action

While some investors chose to remain inactive during the fourth quarter, the private market for deal financing was still active.

In the fourth quarter of the year, the vast majority of private equity-style transactions have been financed by private credit rather than by banks offering loans to a large group of investors. According to PitchBook LCD, 46 leveraged buyouts were funded by private credit up to December 8th, compared to only one that was financed by the syndicated loan market. This trend was also seen in the recently announced take-private of Coupa Software.

Investment firm Sixth Street Partners was the top lender, according to a report from the Wall Street Journal.

Private credit is composed of organizations and funds, including business-development companies, that provide money to businesses directly, and the loans are not intended to be exchanged. These types of changes in activity would usually be initiated by particular moments of instability, such as the beginning of the pandemic in early 2020. However, the fourth quarter was a manifestation of the difficulties Wall Street bankers have experienced all year attempting to syndicate, through the market, loans for buyouts such as those of Twitter and Citrix Systems.

Investors should be aware that banks' Wall Street capital-market operations are not only experiencing a lull, but also contending with other options. Even though nonbanks' financing costs may be increasing at a faster rate than banks' deposit rates, Wall Street banks still have their own funding obstacles that could make it difficult for them to reclaim lost market share.

Private-credit deals are no longer solely dependent on banks. Banks can partake in this type of financing either with their own resources or with their clients' funds. There has been a move away from deals being funded by a group of investors and towards private credit or commercial banks providing loans. According to Autonomous Research, relationship lending increased by 19% in the third quarter of the year compared to the same period in the previous year, while capital-markets lending only rose by 1%.

Banks must consider the costs associated with the transition to the syndicated lending market. This market is a lucrative business that Wall Street investment bankers and trading desks will need to return to in order to experience another surge. However, loans can be a high-risk investment and require a lot of capital, which is currently in short supply for banks.

It appears that the market has been prudent in avoiding more corporate credit risk. It will be interesting to see if private credit is taking advantage of opportunities that the market is unable to absorb, or if they are taking on riskier deals to justify their own fundraising and fees. According to Autonomous analyst Brian Foran, "We need the next credit cycle to find out whether lenders stepped in and supported clients amid market dislocations, or if they underestimated the risk and will regret it later."

As the year progressed, private credit lenders began to take a more cautious approach, as evidenced by PitchBook LCD's data. This data revealed that 28% of private credit-financed deals in the fourth quarter were funded by three or more lenders, a significant increase from the 5% seen in the same quarter the year before. By splitting up deals, lenders are able to take a portfolio approach, rather than investing all their resources into one transaction.

Although diversifying risk may help to some extent, investors should not assume that investment banks can simply rely on others to fail and for deals to come their way. A move away from syndicated loans could have a long-term negative impact on their operations.