Private credit funds step in for companies facing mountains of debt

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Companies with a mountain of debt that comes due in the next three years are turning to the burgeoning $1.5tn private credit industry to avoid defaults and messy bankruptcies, taking out high-cost loans they might otherwise fail to land from traditional investors in US debt markets.

KKR-owned veterinary hospital operator PetVet is the latest large business to hold discussions with private credit funds as it looks to refinance more than $3bn in loans, said people with knowledge of the matter.

A refinancing for the highly-indebted company would help extend its company’s debts, which begin maturing in 2025. KKR, the private equity behemoth, could still attempt to refinance the debt through the syndicated leveraged loan market, particularly if conditions in financing markets improve, people involved in the discussions cautioned. KKR declined to comment.

So-called direct lenders from the private credit industry have become a force on Wall Street, allowing companies to bypass traditional banks when they seek to take out multibillion-dollar loans. Private credit funds are in the midst of a fundraising spree and now lending to companies to help finance blockbuster takeovers and everyday operations.

PetVet’s decision to start discussions with direct lenders over its loans comes on the heels of a string of other large refinancings. Businesses including technology company Hyland Software, fintech group Finastra, shoemaker Cole Haan and manufacturer Tecomet have paid off their obligations with new loans from the private debt industry. They have raised more than $10bn from private lenders for these types of transactions in recent months, Financial Times calculations show.

“Direct lending has the ability to structure and price out different levels of risk . . . that public markets often don’t,” said Craig Packer, a co-president of Blue Owl Capital. “It’s a huge positive for private equity, which otherwise might be faced with limited or painful options.”

The shift to private credit has been fuelled by fractures in the syndicated loan market, where banks arrange financings for companies before selling those loans on to other investors. With so-called collateralised loan obligations — a $1tn market that is the biggest buyer of leveraged loans — largely on the sidelines, corporate America and the private equity industry are being forced to look for alternatives.

Higher interest rates and a weaker economic backdrop raised the spectre that companies could struggle to roll over looming debts. They face more than $350bn in maturities in the leveraged loan market over the next three years, according to data from PitchBook LCD.

A gulf has opened up between the borrowers that can tap syndicated markets and those who have gone to private credit lenders to refinance their floating rate obligations. The deciding factor has primarily been the amount of debt a company is already carrying in relation to its profitability.

Businesses judged to be too highly geared — such as KKR’s PetVet — have started conversations with private lenders over 2025 maturities. PetVet carries high-risk debt ratings, with S&P Global last year projecting its leverage would be more than nine to 10 times its earnings in 2023, a high level.

Complicating matters for the company is that it has roughly $440mn of second-lien debt, loans that would rank below its senior obligations in a bankruptcy. While investors have shown an appetite for higher-rated senior loans, few have been willing to price riskier junior debt.

Private credit funds such as Blue Owl, HPS, Ares, Blackstone and Sixth Street have stepped in to fill the gap for borrowers. In return, they have been paid handsomely.

Interest rates on the loans are often 5 to 7 percentage points above benchmark interest rates, or roughly 10.5 per cent to 12.5 per cent, according to lenders. That compares to a yield of roughly 9.15 per cent on the average single B rated US corporate bond, ICE bond index data shows.

Richard Zogheb, the global head of debt capital markets at Citigroup, said: “A lot of sponsors are looking at private credit as a mini bridge — [saying] ‘let me put this private credit deal in place and have slightly higher leverage, [but] certainty in place for a period of time, and then maybe in a year or two I’ll refinance it in the broadly syndicated loan market.”

Rates can be even higher when lenders agree to allow a company to cover interest payments with more debt. It’s a risky proposition that allows a company to conserve cash while rates are high, but it can backfire if debt burdens balloon.

That has regulators and public market investors raising questions over the risks accruing in the industry should a large number of borrowers struggle to cover their interest costs and ultimately default.

But it is providing — at least for the time being — a way for private equity groups to sustain companies they invested in years ago.

For now, banks and private equity executives acknowledge that private credit funds and hedge funds will be the few investors willing to backstop riskier deals after CLOs’ appetite for risky new loans collapsed.

At the same time, CLOs are beginning to hit the equivalent of a supermarket sell-by date. About 40 per cent of the vehicles by the end of 2023 will exit their so-called reinvestment period — a date that once hit restricts their ability to invest in new debt.

“As that’s starting to wind down, it’s harder to get a sense for how much capacity there really is on the public side of markets,” said Milwood Hobbs Jr, a managing director at Oaktree. “What sponsors and buyers want in current markets is certainty of execution.”

Additional reporting by Sujeet Indap in New York