Key Takeaways
- The diversity of borrowers, backed by a broad mix of sponsors, may help diminish concentration risk of assets that business development companies (BDCs) hold in their portfolios.
- Private equity sponsors back nearly two-thirds of the borrowers whose loans are held by BDCs, and sponsor-backed borrowers account for a larger share of direct lending assets than broadly syndicated loans.
- While there is diversity among sponsors, the largest are more highly exposed--the most active 10% are involved with 50% of issuers.
- For smaller sponsors with only a single deal each, nearly 90% of the borrowers backed by these single-deal sponsors are borrowers with non-broadly syndicated loans.
Private equity (PE) has contributed to the increase in corporate debt over the past decade. It has fueled the growth of both jumbo buyouts across large corporate entities and direct lending to small and medium-size entities. However, as credit conditions continue to strain borrowers, it's important to gain clarity about how PE is woven into the financing of speculative-grade borrowers. And, even more importantly, how significant is their commitment to struggling borrowers?
To evaluate this, S&P Global Ratings Credit Research & Insights looked at entities in business development company (BDC) and interval fund filings for the second quarter of 2023. We found that the diversity of sponsors, and diversity of borrowers across portfolios, may help diminish risk by spreading it more broadly across portfolios.
Private Equity Is The Most Common Ownership Structure Among Companies With Debt Held By BDCs And Interval Funds
We extracted holdings from 133 portfolios, consolidated into one entity any borrowers with multiple names, and identified which of these were sponsored. Our research found about 5,400 unique corporate borrowers with debt held by BDCs, excluding holdings of collateralized loan obligations (CLOs) and various investment vehicles such as special purpose acquisition companies, REITs, and asset-backed securities.
PE represents the dominant ownership structure, with about 64% of those borrowers being sponsored versus 36% not sponsored because of public equity, family ownership, or some other form of private ownership (see chart 1). For the 30% of borrowers with broadly syndicated loans (BSLs), which are more likely to be large corporates with public equity, the PE ownership share is slightly lower, at 60%. For the 70% of borrowers not tapping the BSL market, PE backing rises to 66%, with the not-sponsored segment skewing toward private ownership in the form of family-owned, venture capital-backed, and start-ups.
Chart 1
Issuers of BSLs are generally large corporate entities. In contrast, the non-BSL market--mainly direct lending--is a primary driver of lending for small and medium-size entities.
Supporting this view is that nearly half (46%) of the BSL-backed issuers are in four or more of the 133 portfolios reviewed, compared with just 21% of direct lending transactions. In fact, 45% of direct lending transactions are in just one portfolio, while 21% of BSL transactions are found in only one portfolio. Diversity is important to portfolios, and the portfolios we reviewed showed a great deal of diversity among direct lending assets.
Borrowing Is Concentrated Among The Largest Sponsors
While larger, more active sponsors have an outsize impact on the market, a significant amount of sponsor diversity exists across the board, and smaller sponsors are a critical part of the direct lending landscape. Our analysis identified approximately 840 different sponsors within the 3,500 PE-backed entities. The largest sponsors play an outsize role--the most active 10% are involved with 50% of borrowers (see table).
On the other end of the spectrum, single-deal sponsors (those involved with just one transaction in the analysis) represent 50% of total sponsors, but their companies are just 12% of borrowers.
| The top 10% of sponsors account for the majority of sponsor-backed borrowers | ||||||
|---|---|---|---|---|---|---|
| % of all sponsors | % of all borrowers | |||||
| Largest sponsors (15 or more transactions) | 10 | 52 | ||||
| Middle sponsors (2 to 14 transactions) | 40 | 36 | ||||
| Single-deal sponsor | 50 | 12 | ||||
| Note: Data based on loan asset holdings of BDC and interval funds reported from 2Q 2023. Source: S&P Global Ratings Credit Research & Insights. | ||||||
While single-deal sponsors account for about 12% of the total number of borrowers held in BDC portfolios, these are skewed toward direct lending transactions. For companies backed by a single-deal sponsor that has only one sponsored company among the pool of BDC assets, 11% are BSL-funded companies and 89% are not BSL funded. In contrast, of the largest sponsors (backing 15 or more entities), 21% are BSL-funded, nearly double the single-deal sponsor level.
While diversity helps diminish risk, tough economic conditions and higher-for-longer interest rates make it all the more important that market participants gain as much transparency as possible regarding how these issuers are weathering the storm.
Reporting On BDC And Interval Fund Portfolios Provides Insight Into A Market Lacking Transparency
While investors frequently note the lack of transparency in the private credit market as a challenge, the public reporting on BDC and interval fund asset portfolios provides insight into this market. Of the 5,400 entities in this analysis, the BSL transactions (30% of issuers) mostly have public ratings.
In addition, S&P Global Ratings provides credit estimates (a point-in-time confidential indication of the likely long-term credit rating) to the CLO managers for the approximately 2,000 entities whose loans are held in middle-market CLOs. Our analysis indicates 25% of the borrowers in these BDCs and interval funds also have credit estimates, raising the total coverage of rated issuers or borrowers with credit estimates to 55% (see chart 2).
Clarity on the portion of the market that is rated as well as the share of the market that is backed by known PE sponsors can bring more transparency to the private credit market. As PE has driven growth in the leveraged finance market, these connections between borrowers and sponsors shed light on this market.
Chart 2
Related Research
Business Development Companies' Assets Provide A Glimpse Into The Private Credit Market, Oct. 2, 2023
This report does not constitute a rating action.
| Primary Contacts: | Ruth Yang, New York (1) 212-438-2722; ruth.yang2@spglobal.com |
| Evan M Gunter, Montgomery + 1 (212) 438 6412; evan.gunter@spglobal.com | |
| Secondary Contact: | Jon Palmer, CFA, Austin 212 438 1989; jon.palmer@spglobal.com |
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