The rapid expansion of private credit is creating a supply/demand imbalance that is again pressuring spreads and underwriting terms, according to Fitch Ratings analysts and external panelists at the rating agency’s recent private credit forum held in Chicago.
While the prospect of increased regulation kept banks largely on the sidelines last year, Managing Director Meghan Neenan noted that banks had become more active in recent months as seen with several bank/non-bank partnerships of late. This raises the question of how the pending return of banks and other syndicated market participants will shape the direct lending space.
Competition is likely to intensify, particularly in the upper middle market. While leverage and covenants are holding up, spreads are expected to come under more pressure. In response, Senior Director Lyle Margolis said some lenders are conceding on terms like pricing in order to maintain key relationships. Middle market credit performance outperformed Fitch’s expectations last year, although there are signs of more divergence in credit metrics for business development companies (BDCs).
As direct lending continues to expand, issuance of products like middle-market collateralised loan obligations, feeder funds and bilateral facilities continues to grow, according to Managing Director Derek Miller. As new investors add exposure to private credit across different vehicles and structures, a primary focus for lenders will be tailoring the issuance product to fit both investor and lender needs.
Rapid growth and numerous new entrants into the private credit space has raised the notion of systemic risk, though the IMF downplayed immediate private credit systemic concerns in a recent report. While the explosion of semi-liquid products that allow for redemption risk could result in the forced selling of assets, Neenan noted that quarterly redemption caps will prevent ‘runs’ on a fund.
