(Bloomberg) -- The biggest names in private credit have raised the most investment-grade debt ever this year, at a time when they already have record levels of cash and are fighting to stay competitive with rival banks.
The $1.7 trillion private credit market — dominated by the likes of Ares Management Corp. and Apollo Global Management Inc. — has had a stellar year. Lenders are inking multi-billion dollar partnerships with would-be competitors, bankers are leaving for lucrative private credit roles, and some foreign investors are chasing direct loans with 22% yields. All of this has led a key group of private lenders, the firms known as business development companies that are often publicly-traded, to sell $21.8 billion of investment-grade bonds this year.
That’s a record level, more than the $21.4 billion sold in 2021, Deutsche Bank AG data shows. And it’s despite the growing risks involved: The pace of private credit defaults has risen to 5%, many private debt funds are rated just one notch above junk status, and companies are trying to swap out of expensive private deals or shift assets away from direct lenders.
Still, the momentum isn’t slowing. Just last week, a Blackstone Inc. private credit fund raised $800 million of investment-grade bonds and an Ares fund raised $750 million, while a Blue Owl Capital Inc. fund sold $1 billion a few weeks earlier, and Sixth Street Lending Partners sold $600 million. Around 20 BDCs have tapped the high-grade market this year, Bloomberg Intelligence estimates. Blue Owl Credit Income Fund leads the charge with $3.4 billion sold, followed by Ares Capital at $1.95 billion, Apollo Debt Solutions at $1.6 billion, Blackstone Private Credit Fund at $1 billion, and HPS Corporate Lending Fund at $950 million.
“One of the reasons we’re seeing more and more volume is because the market has grown. It’s proportional to the scale of the overall private credit market,” said Mike Patterson, governing partner at HPS Investment Partners. “We’re also seeing consolidation of power, as larger players have more access to attractive financing options than the smaller, newer ones. Certain players have outgrown bank financing, and they need access to these big pools.”
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Business development companies were first created in 1980 by Congress to boost lending to small and mid-sized American businesses. They typically raise equity from investors to issue loans to companies that banks might consider too risky to lend to. It’s only over the last few years that they’ve started selling corporate bonds.
The Federal Reserve’s recent interest-rate cut and expectations for further reductions mean that borrowing costs for BDCs are expected to come down, supporting more bond sales. On top of that, investment-grade spreads — a measure of borrowing costs — have been tightening to levels last seen in 2021.
“Spreads have come in and that makes debt issuance more palatable,” said Mark Wasden, a senior vice president in Moody’s Ratings’ private credit team, referring to the added premium over US Treasuries that high-grade borrowers pay.
Tight credit spreads, growing optimism the US will nail a soft landing, and a banking sector that’s in better shape since being rocked by crises last year have all contributed to BDCs’ “receptive” capital markets treatment, according to Bloomberg Intelligence analyst David Havens.
“As long as the economy remains more or less on track, the stars are in alignment for another year of record issuance next year,” he added.
Buyers of BDC debt, like wealthy investors, pension plans, insurance companies and sovereign wealth funds, have also become more familiar with the bonds over time, helping boost sentiment, say market participants. The bonds trade more like BB rated junk bonds, which appeals to investors hunting for higher yields as the Fed embarks on its easing cycle, they added.
“There’s increasing dispersion among managers, too,” said Victoria Chant, global head of capital formation for Blackstone Credit & Insurance. “Managers that stand out will go out and get better execution.”
But it’s not all good news. Investment giant Pacific Investment Management Co. — one of the biggest skeptics on private credit — is keen to price BDC debt appropriately. That means focusing on leverage, liquidity premium, payment-in-kind and the quality of underlying assets among other factors, according to Sonali Pier, multi-sector credit portfolio manager at the firm.
“We’re discerning case by case based on the issuer,” she said. “The most important thing is that we’re checking on that credit quality. It’s very clear to us that some of this is focused on middle-markets, meaning the resilience is going to be naturally lower in this space than say a typical investment-grade credit.”
Others are skeptical, too. “We have been bullish on the space for as long as we can remember but do think it is time to pare down risk,” JPMorgan Chase & Co. analysts led by Kabir Caprihan wrote in a report last week, noting that there are plenty of names that are mispriced.
BDCs also become less attractive as money keeps pouring into private credit and investors get more comfortable with the debt, according to Scott Kimball, chief investment officer at Loop Capital Asset Management.
“You do get a yield pickup, but all-in yields are a lot lower than they were, so it’s not as compelling as it was,” he said.
From a ratings agency perspective, Ana Arsov, Moody’s global head of private credit, says the BDCs they rate have largely maintained strong asset quality albeit with varying levels of performance.
“Early signs of credit issues include a rise in payment-in kind investment income and an increase in non-accruals,” she said. The three-letter acronym ‘PIK’ refers to debt that allows companies to defer cash interest payments, while non-accruals are investments that lenders are in danger of losing money on. “We have taken appropriate rating actions this year based on the variations we have observed in these indicators,” Arsov added.
Last week, the credit grader cut the outlook on an $8 billion publicly-traded private credit fund — Prospect Capital Corp. — to negative, citing high PIK levels relative to peers. A day earlier, Moody’s upgraded funds tied to Blackstone and Ares to Baa2 from Baa3, citing strong asset quality and profitability, respectively.
Still, BDCs aren’t going anywhere soon.
“It feels like every week we get a new ticker added to the index,” wrote the JPMorgan analysts. “And yes we do wish they were not 5-6 characters long.”
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