Easy monetary policy in the form of low rates combined with quantitative easing saw capital markets flushed with liquidity following the Global Financial Crisis (GFC) through the pandemic and briefly beyond. There was plenty of capital available for deployment across a range of asset classes, and the U.S. broadly syndicated loan market grew steadily from $236 billion in 2010, peaking at $1.43 trillion in 2022, based on PitchBook LCD data.

But tides turn. Now, after rates rose sharply in 2022 and 2023, investors and borrowers turned to other forms of credit, and growth in the syndicated loan market paused. Loan issuance fell 26% year over year in 2023 following a drop of 44% in 2022. At $328 billion, 2023's leveraged loan issuance volume was the lowest since 2010, based on PitchBook.

As broadly syndicated loan volumes fell, financing conditions grew more challenging--especially for more highly leveraged borrowers such as those rated in the 'CCC' category. Some borrowers departed the broadly syndicated market, turning to speculative-grade bonds for refinancing or opting for private credit instead. Slowing syndications, coupled with an uncertain market, made it a challenge for issuers to tap the syndicated loan market, especially during times when public markets faced pronounced uncertainty from the rapidly changing macro and geopolitical environment.

The Private Credit Boom

The pullback in broadly syndicated loans opened a door for private credit, which hitherto had provided lending predominantly to lower and traditional middle markets. The private market offered a much needed reprieve and liquidity. While terms could be stricter and pricing higher in the private credit market, they were more predictable and not subject to the volatility in the syndicated loan market. Sponsors and issuers found the certainty and predictability of direct lending particularly attractive during a volatile time.

With more assets, more dry powder, and through cooperation in small club deals, private credit has become increasingly competitive with publicly traded debt (including broadly syndicated loans and speculative-grade bonds). For instance, last year's record $4.8 billion loan to Finastra from a club of private lenders to refinance broadly syndicated loans maturing this year was of a scale that would have been inconceivable for private credit lenders in the past. This didn't happen overnight--private credit has been steadily growing over the last decade, with assets under management of private credit firms rising to over $1.6 trillion (according to PitchBook).

Borrowers' Credit Quality Fueled The Transition

While Finestra may be the largest example of a borrower that shifted to the private market for funding from the public market, it's not alone. As leveraged loan issuance fell in 2023 to its lowest volume since 2010, several borrowers turned to private credit for funding solutions.

To better understand the characteristics of borrowers that made this shift from public to private over the past year, we sampled 25 of such borrowers. While the availability of funding appears to have enticed issuers to private credit, other likely factors include certainty of execution in relationship-based lending and the flexibilities it entails.

For data on issuers that made such a shift, we turned to our credit estimates. Credit estimates are our credit opinion on the underlying instruments held by middle-market collateralized loan obligations (CLOs) that we rate. Several private credit managers use a CLO to gain leverage as well as to diversify their sources of funding. They issue middle-market CLOs that are backed by loans issued by entities that they underwrite for their other direct lending funds, vehicles, business development companies (BDCs), etc.

Unsurprisingly, one of the drivers of the shift to private credit was issuers' credit quality and the challenges they faced tapping the syndicated loan market. About a third of these companies were rated in the 'CCC' category. Their credit profile would have hampered their ability to refinance in the broadly syndicated loan market.

In 2023, new issuance volumes for both bonds and loans rated 'CCC+' and lower fell to their lowest since 2009, as there was little investor demand. Adding to funding strain for these borrowers, syndicated loan CLO managers managed constraints for holding 'CCC' credit. Beyond a certain threshold--typically (7.5% of the CLO portfolio)--'CCC' rated assets in the portfolio take a haircut in the overcollateralization coverage calculation, which could have ramifications in the waterfall of payments. However, middle-market CLOs that hold private credit loans have more flexibility because this threshold is normally set at a higher 17.5%.

While many sources of funding for issuers rated 'CCC+' or lower dried up in 2022 and 2023, private credit created a reputation for providing "bear market capital." Even in adverse conditions, funding is available, but at a cost.

However, the majority of the borrowers that we reviewed that transitioned to the private market during this time were rated above the 'CCC' category. Almost half the issuers we sampled that transitioned to private were rated 'B-' before S&P Global Ratings withdrew its rating. The private markets have traditionally had a premium over syndicated loan markets. On average, the spread difference between the syndicated loan and private credit market was close to 200 basis points (bps) and the median was 175 bps.

There was no sector focus or sector bias because companies from multiple sectors transitioned to private markets. However, the sectors from which most companies transitioned were media and entertainment, capital goods and consumer products.

Other Factors Played A Role

There were issuers rated higher than 'B-' that also moved to the private credit market. Despite generally accommodative financing conditions for these borrowers through most of 2023, their migration to private credit likely indicates reasons beyond credit, such as confidentiality (or the appeal of fewer public reporting requirements) and flexible terms and pricing options.

Given uncertainty in the funding market in 2023, certainty of execution could also be paramount for some issuers. The sharp rise in benchmark rates in 2022 and 2023 as part of the Fed's response to inflation brought a lot of uncertainty to the market, stalling mergers and acquisitions, leveraged buyouts (LBOs), and other transactions as investors retracted. Further, some banks were saddled with their inability to syndicate loans underwritten in better times when the market stalled. The aversion to risk and the unwillingness of some investors to lend to the lowest-rated borrowers, also meant there was limited appetite for lending, with limited opportunities for funding.

The Market Evolves

The ease, speed, and certainty of execution for completing a deal seems to have been a major focus for many borrowers in recent years, and this has helped to make private credit more attractive. However, pricing remains more attractive in the broadly syndicated market, and the rapid compression of spreads in January highlighted this. The unexpected resilience of the U.S. economy, coupled with periodic glimpses of slowing inflation, has lifted investor sentiment from last year, and this appears to be tilting the balance of funding yet again.

S&P Global Ratings' expectation is 2.5% GDP growth, with above-target inflation limiting the Fed's ability to ease rates this year. While expectations for the Fed's first rate cut continue to be pushed back, issuers may not be willing to wait to issue new debt given that favorable windows for financing conditions may not last.

Investor demand and enthusiasm for credit has caused spreads for U.S. leveraged loans to compress to the tightest levels since the just after the start of the pandemic. This has caused issuers in the syndicated loan market to opportunistically refinance and address their upcoming maturities. According to LCD, January experienced the highest levels of refinancing in more than a decade. However, there is still a dearth in LBO and merger and acquisition activities and an absence of new loans underwritten for such transactions. This lack of term loans comes at a time when there is sustained demand from CLOs for new leveraged loans--providing an opportunity for banks and issuers to continue looking at options such as refinancing and dividend recaps.

Back In Syndication

There is an added attraction for some of the issuers in the private credit market to refinance in the syndicated loan market, given the spread compression there and consequent widening of the spread premium in the direct lending market.

Some borrowers are now turning to public markets to refinance private credit. LevFin Insights reports that over $14 billion of broadly syndicated loan volume was issued in the first quarter this year to refinance private credit debt. This includes new issuance from SupplyOne Holdings Co. and Dye & Durham Corp., each of which had newly assigned ratings in March as they issued new debt to refinance their existing capital structures. With some issuers turning to public markets to refinance private credit, some that had already made with switch from public to private are going back to public.

We've seen some issuers make the switch based on the funding opportunities available in private and public markets.

Chromalloy Corp., was acquired by Veritas Capital through an LBO in 2022 with debt that was funded privately. But Chromalloy reduced its funding costs when it turned to the broadly syndicated loan market this year to refinance existing debt. LevFin Insights reports that the issuer reduced its credit spread by 325 bps by turning to the broadly syndicated market.

Kodiak Gas Services also switched between public and private funding. In March 2019, when it was rated 'B', investors pushed back on a bond offering, requested tighter documentation, and pushed for a yield above the 9.25%-9.50% guidance. Rather than accept investor demands, Kodiak withdrew its bond offering and its issuer credit rating, and it turned to banks and private sources for funding.

After biding its time, Kodiak recently returned to the public credit markets as speculative-grade bond issuance and leveraged loan issuance surged in early 2024. Kodiak's new $750 million notes issue from January 2024 yields 7.25%. It will use the proceeds of these notes, in conjunction with an acquisition, to repay some existing debt. We now rate the issuer 'B+'.

In other cases, we've seen borrowers shift between public and private sources of funding following a default.

Tailored Brands Inc. is a specialty apparel retailer of men's formalwear in the U.S. and Canada. This issuer defaulted in 2020 when it missed an interest payment, and S&P Global Ratings lowered its rating to 'D' from 'CCC+'. The issuer subsequently requested that we withdraw its rating and it received $75 million in private funding in March 2021. Tailored Brands returned to the public credit markets in September 2023 with a newly assigned 'B' issuer credit rating.

Diamond Offshore Drilling Inc. defaulted in 2020, going to 'D' from 'CC' after it missed an interest payment as oil prices collapsed and demand for contract drilling services fell. Diamond emerged from chapter 11 in April 2021, and it turned to pre-petition investors and private sources of funding for the restructuring. In September 2023, S&P Global Ratings assigned a new 'B' rating to Diamond as it launched a $500 million offering of senior secured second-lien notes, using proceeds of this issue to repay existing debt.

Market currents shift directions. Anticipation of interest rate cuts and investors' desire to lock-in current interest rates might just mark another directional shift. While rising rates and challenging financing conditions may have pushed some issuers toward private markets, new funding opportunities and lower costs may draw them back to the public ones.

Related Research

• Private Credit And Middle-Market CLO Quarterly: Not A Sunset, Just An Eclipse (Q2 2024), April 24, 2024
• Private Credit Allows Defaulted Borrowers To Buy Time, S&P Global Report Says, Nov. 30, 2023