Private credit — a growing source of capital for small- and medium-sized companies — will likely rebound this year across several deal categories and sectors following a slump in 2020, according to a Katten survey of 112 lenders and private equity investors.
Negotiations on terms may prove lively, with half of private equity investors planning a more aggressive approach and 55% of lenders expecting pressure to pull back from “sponsor-friendly” deal terms, Katten said.
Three out of five survey respondents said they are not very prepared to meet the regulatory mandate to transition the benchmark for financial contracts from the London Interbank Offered Rate (LIBOR) to a new reference rate.
The private credit market has boomed since the Great Recession prompted banks to reduce riskier lending.
At the same time, record-low interest rates have compelled a “reach for yield” into alternative investments such as private credit, which is also known as private debt, non-banking lending or shadow lending.
When negotiating private credit, companies can often customize terms. For their part, lenders can gain yields that far exceed those on the typical investment-grade corporate bond. Insurance companies, public pension funds and family offices are among the most active lenders.
The Federal Reserve and other regulators have expressed concern about the risks in private credit, where oversight is comparatively lax.
Private debt assets under management will probably surge to $1.46 trillion in 2025 from $887 billion in June 2020 for a 65% increase, Preqin predicted in a February report. Private debt is the third largest private capital asset class after private equity and real estate.
Twenty-one percent of lenders and 19% of private equity investors expect private credit deal flow to surge more than 30% this year, Katten found.
Lenders and private equity investors see solid prospects for growth in financial services and information technology, and are also optimistic about health care and communications services.
Only two in five respondents reported being "very prepared" to switch their financial contracts from LIBOR to the Secured Overnight Financing Rate (SOFR) by the regulatory deadlines, Katten said. LIBOR is the reference rate for trillions of dollars in mortgages, business loans, derivatives and other contracts worldwide.
Despite regulators' repeated warnings since 2017, U.S. dollar LIBOR use has increased to nearly $223 trillion in outstanding financial contracts from about $200 trillion in 2018, Fed Vice Chair Randal Quarles said last month. He called for a halt in the use of LIBOR in new contracts.
The U.K. Financial Conduct Authority, the administrator for LIBOR, announced last month that it will delay until mid-2023 the sunsetting of some of the most commonly used tenors of the benchmark rate.
The final fixings for most LIBOR rates — including 1-week and 2-month U.S. dollar LIBOR — will be made on Dec. 31, 2021, but other U.S. dollar tenors may continue until June 30, 2023.
Adoption of SOFR has accelerated during the past several months but, because of some disadvantages, is far from eclipsing LIBOR.
SOFR is based on overnight repurchase agreements secured by Treasuries and, unlike LIBOR, does not enable treasurers to make forward-looking rate calculations. LIBOR is based on London banks' estimates of what they would be charged when borrowing from other banks.