THERE ARE many ways to tell the story of the turnaround in America’s capital markets since last spring. The focus has been on public markets, notably the wondrous surge in share prices. Yet the change in fortunes of private equity (PE) is perhaps more remarkable. A year ago Blackstone, a PE giant, reported a first-quarter loss of more than $1bn. A reckoning seemed overdue. Widespread defaults on overborrowed PE-owned businesses were expected. A year on, Blackstone has reported record profits of $1.75bn. So much for comeuppance.
Its rude health owes a lot to the speed, as much as the extent, of recovery in asset prices. Buyout shops barely had time to mark down their portfolio companies in line with a falling stockmarket before share prices suddenly recovered. Dealmaking has picked up to a frantic pace. Competition from corporate buyers means that buyout firms must move quickly. Where they have an edge is in raising debt. In fact the premium on speed in PE is why you should expect to see a sharp pickup in a related corner of capital markets—private credit.
Private credit mainly serves mid-sized companies that are acquiring something or undergoing change of some kind—buying out a family member’s stake; refinancing their bank debts; and so on. More often than not, this change will be carried out under the auspices of a PE sponsor and require a lot of borrowing. Banks used to finance this sort of thing, but not anymore. To access the public markets, a company must meet the demands of regulators. It must be biggish and profitable, with a history of pristine financial statements. A lot of companies do not tick the boxes.
Private credit has elements of both bank and capital-market finance. It is like a bank loan in that it is tailored to the borrower and does not usually change hands in markets. It is like a publicly traded bond in that the end-investors are pension and insurance funds looking for regular fixed income. The border between private and public credit is blurry. The defining factor is how widely a loan is distributed. The highest-profile part of private credit is the market for leveraged loans, which are fixed-income instruments sold to syndicates of investors. The more widely a loan is distributed the more liquid it is. A broadly syndicated loan might be sold to 100 or more lenders. By contrast, the number of parties to a truly private deal is often in the single digits.
The bigger PE firms have private-credit arms. The set of skills required is similar, says Mike Arougheti of Ares, a private-asset manager. Both types of investor need to make sound judgments about the growth of cashflows, and the hazards around it, for companies that are not widely researched. There are obvious synergies. Say a PE firm has carried…
Read More: Why private-credit markets are due a growth spurt