August 1, 2024 — Private credit continues to deliver strong risk-adjusted returns for investors. Senior secured loans to high-quality, mid-market companies are currently generating low double-digit returns with strong downside management due to substantial equity cushions and robust lender protections. Borrowers continue to demonstrate resilience and are performing well, which has resulted in improved investor confidence and increased capital flows across the market.
We’ve seen a few key themes play out in the market:
- Demand for refinancings and capital for add-on acquisitions has remained robust, with borrowers continuing to turn to private credit for financing solutions. LBO activity and related financing has increased relative to the prior year, though volumes remain below historical average levels.
- While recent economic data has indicated some softening in the economy, market participants continue to expect interest rates in the long term to remain at higher levels than seen over the past decade. To date, market defaults have remained stable at fairly benign levels, with a lower ‘tail’ risk of sharply rising default rates.
- As a result of the above factors, spreads have continued to compress across the credit markets, while overall yields remain attractive. We see continued bifurcation between the upper and core mid-market on pricing and terms, with core mid-market transactions showing more signs of insulation from competitive pressure and lower overall leverage. We are also seeing strong relative value in the UK / Western Europe where market liquidity dynamics favour lenders with dry powder to transact on attractive terms.
Non-LBOs: Count in US Broadly Syndicated vs Private Markets
Source: Pitchbook. Data through June 30, 2024. Count excludes repricing and extension amendments. Syndicated data is for the Morningstar LSTA US Leveraged Loan Index. Private credit count is based on transactions covered by LCD News.
LBOs: Count in US Broadly Syndicated vs Private Markets
Source: Pitchbook. Data through June 30, 2024. Syndicated data is for the Morningstar LSTA US Leveraged Loan Index. Private credit count is based on transactions covered by LCD News.
Over the past two quarters we have seen an increase in new issue volume from the broadly syndicated loan (BSL) market, which signals improved investor confidence around both the economy and borrower performance. At the upper end of the market (>$75M EBITDA), competition between BSL and private credit has resulted in spread compression and greater concession on terms. Further driving competitive pressure is the record levels of private credit dry powder in the upper mid-market. The core mid-market (<$75M EBITDA) has been more insulated from competitive pressures, resulting in better pricing, lower leverage and continued strong lender protections, including maintenance covenants.
We continue to see certain pockets of softness in the economy, including in sectors with consumer discretionary demand drivers and among highly-levered businesses, but most borrowers continue to demonstrate resilience in the heightened interest rate environment. Market defaults in Q2-24 were down quarter-over-quarter, with the trailing 12-month default rate of the Morningstar LSTA US Leveraged Loan Index (LLI) ending the quarter at 1.6%, just below the long-term average.
Overall, the asset class has remained resilient, and we believe today’s attractive yield environment has the potential to provide private credit investors with strong absolute and risk-adjusted returns. In particular, mid-market private credit has historically delivered lower loss rates to comparable public market investments over the long term due to conservative structures and strong lender protections.
Current Gross Asset Yield (As of June 30, 2024)
Source: Reorg for mid-market senior secured loans based on deal size of $150M to $500M and Pitchbook/LCD for broadly syndicated loans and high yield bonds as of June 30, 2024.
US Leveraged Loan Index (LLI) Trailing 12-Month Default Rate
Source: Pitchbook/LCD; Morningstar LSTA US Leveraged Loan Index. Trailing 12-month default rate is based on number of defaults divided by total issuers. As of June 30, 2024.
Important Notices: This document is for informational purposes only and does not constitute a general solicitation, offer or invitation in any Northleaf-managed product in the United States or in any other jurisdiction and has not been prepared in connection with any such offer. The views and opinions expressed herein do not constitute investment or any other advice, are subject to change, and may not be validated by actual events. There can be no assurance that any of the trends highlighted above will continue in the future, Certain of the information set forth herein was gathered from various third-party sources which Northleaf believes to be accurate, but has not been able to independently verify.