đŸ€ȘLending, Lending, LendingđŸ€Ș

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Sunday’s looooooong special report, “CLO NO!?!?,” about Deluxe Entertainment, collateralized loan obligations (and their limitations), leveraged lending, EBITDA add-backs and other fun lending stuff sparked A LOT of interest. If you’re not a Member, you missed out and now thousands of people you’re competing with for business are officially smarter than you. Go you!

One thing we didn’t have time (or, given the length, space) to note is how private credit lenders take exception to being lumped in with the syndicated leveraged loan market and, by extension, CLOs. Indeed, “leveraged loans” are a rather broad category and there are differences between lenders that ought to be acknowledged: private credit vs. public BDCs vs. private BDCs vs. syndicating banks, etc., etc.

Regardless of distinctions, however, there’s clearly a ton of green out there looking for some action. To point, back in September, Bloomberg noted:

Globally, private credit, which includes distressed debt and venture financing, has ballooned from $42.4 billion in 2000 to $776.9 billion in 2018. By one estimate, the total is likely to top $1 trillion in 2020.

Public pension funds, insurance companies and family offices are some of the biggest investors putting money to work in private credit. Private equity firms themselves have also flooded into the space, forming their own credit arms or raising cash for private credit vehicles, along with private equity funds of funds from these investors. The frenzy has turned some lending start ups into heavyweights almost overnight. Owl Rock Capital Partners — a New York firm founded by Blackstone, KKR and Goldman Sachs veterans — has amassed $13.4 billion of assets since it started in 2016.

Bloomberg continued:

An influx of new lenders and fresh cash in the space has contributed to cutthroat competition and looser covenants -- terms lenders impose on borrowers to help protect their investments -- in addition to thinner returns. Regulators in Europe have taken note of private credit’s boom, saying its growth has been accompanied by signs of increased risk-taking. UBS credit strategists have called private credit “ground zero” for concerns due to the increased leverage on direct loans. Covenants can also be undermined when borrowers goose their earnings by, for instance, claiming savings from ambitious cost-cutting programs that may never come to pass. Jamie Dimon, CEO of JPMorgan, has also said some non-bank lenders may not survive an economic slump because they’re holding lower-quality loans -- and their disappearance could leave some borrowers “stranded.”

Hmmm. It sure sounds like the aforementioned distinctions may be without a difference given the market dynamics.

In response, the private credit guys — and, yes, they’re overwhelmingly dudes — love to say that they’re not necessarily overrun by the supply/demand imbalance that generally exists elsewhere in credit. “We have proprietary credit analysis techniques,” they’ll say, thumping their vested chests in the process. “We have specialization in category XYZ,” they’ll argue in an attempt to de-commoditize themselves. Boasts notwithstanding, any actual or alleged competitive differentiation hasn’t, in fact, insulated most lenders from macro market trends where sponsors have the power and lenders capitulate on the regular. No doubt, private equity sponsors are playing competing BDCs and private credit providers against one another to get deals done with favorable terms. Otherwise, we wouldn’t be reading about EBITDA add-backs, and cov-lite or cov-loose, etc.

Still, they’re combative. “Credit quality is more important than documentation,” they’ll say, highlighting how they loan with the intent to satisfy the life cycle of the paper rather than dole it out or ditch it. Management. Industry. Financials. No cyclicality. The documentation is less relevant when these things line up, they’ll say. Do that right and they won’t have to worry about what happens when the thing goes sideways. Counterpoint: restructurings wouldn’t exist if underwriting was 100% bullet-proof.đŸ€” 

Alternatively they’ll deploy the Trump defense. “Sure, sure, our docs suck. But the worst private credit doc is better than the best syndicated loan doc.” Or they’ll argue that they’re able to get favorable pricing in exchange for the lax nature of the docs. Maybe. We suppose we’ll also see in due time if that pricing properly compensates lenders for the risks they’re taking.

Look, we get that the type of loans that now constitute “private credit” fared relatively well in the last cycle. We also understand priority and acknowledge that top-of-the-capital-structure loans ought to be, from a recovery perspective, fine places to play. But to cavalierly play it like there isn’t reason for concern is disingenuous.

Apropos, Golub Capital just hired new Workout Counsel. He — and his ilk — may be busier than these private credit lenders care to admit.