Private debt providers have taken market share from the syndicated loan market, LCD data suggests. But by how much?

The question has been top-of-mind as the pandemic-triggered market deep freeze recedes, and competition for attractive deals heats up. The LCD data below shows how much the syndicated market has shrunk over time for midsized borrowers. Among broadly syndicated loans, the share below $250 million declined to 9% in 2020, the lowest reading since LCD began tracking this data.

Presumably, middle market borrowers have turned to the private credit market for their financing needs.

Although the evidence of a falling share of syndicated deals to middle market borrowers is clear, measuring the actual size of the private debt market, based on loan issuance, remains challenging. A commonly used gauge of the private credit market's size is fundraising volume targeting direct lending strategies.

But an accurate count of private credit loans remains elusive. While a syndicated loan deal can have dozens of lenders, private credit transactions get done with far fewer. Deals that have a handful, or two to three lenders, are regularly completed without details escaping beyond non-participants.

In an example of the delicate dance between private credit and the syndicated loan market, look no further than the current state of the second-lien debt market. With demand strong from institutional investors that typically invest in broadly syndicated loans, borrowers are refinancing higher-priced, privately placed second-lien loans in the syndicated market.

This trend is causing a headache for private credit providers that have traditionally provided second-lien debt. These lenders are at once grappling with repayments; extreme competition over deals perceived as pandemic-resistant; as well as challenges from COVID-19 lockdowns for borrower companies, such as more companies choosing to pay-in-kind interest as a way to preserve cash.

Private credit provider Ares Capital Corp., which competes with other private credit providers as well as with banks for lending opportunities, recently offered some color about the balance between private loan deals and syndicated solutions.

Last month, Ares Capital CEO Kipp deVeer said that like during other periods of market volatility, borrowers and private equity sponsors turned toward private debt markets during the COVID-19 pandemic. As a result of the pandemic-induced market volatility, deVeer believes the company likely took market share from competitors in 2020.

"During uncertain times, private capital solutions tend to be more valuable. Syndicated deals tend to be tougher to get done. Market volatility is not something folks want to take on," deVeer said in a Feb. 10 call with shareholders to address the lender's quarterly earnings.

Even as Ares Capital was "playing defense" on its portfolio when market volatility was at an extreme, it was open to new deals throughout 2020, deVeer said.

"Not only do you want the certainty of a private solution, but you value a partner more who you know is going to be there for the long haul ... who hasn't closed their doors for new business for any period of time. We didn't do that."

Unlike broadly syndicated loans, loans from private credit providers tend to be illiquid investments. Ares Capital typically underwrites deals it can hold to maturity. But it also has the ability to sell them to other investors when it makes sense. A recent example was financing for Capstone Logistics LLC. In October, Ares led a $625 million first-lien term loan due 2027 backing a buyout of Capstone by H.I.G. Capital.

"Sometimes pricing relative to where you underwrote tightens, and your desire to hold decreases from where it was on an underwriting basis. We set up a fully functioning capital market and syndications team to take advantage of tightening markets," deVeer said.

In another view of the private credit vs. syndicate loan markets, Owl Rock Capital Corp. CEO Craig Packer believes the opportunity set for direct lending to middle-market companies has expanded, despite the high competition for new deals.

"Our sweet spot is in the $70 million to $110 million EBITDA business. The good news is that that opportunity set is growing. Five or six years ago, those companies didn't do direct deals. The pool of capital wasn't there for them to take advantage of," Packer said in the company's fourth-quarter earnings call on Feb. 24.

"With us, and the rise of some other large direct lenders, the private equity firms have now realized they can do large financings direct, and not go to the syndicated market. As many of them become more comfortable with that, I think the opportunity set will continue to grow."