Direct Lending Slowing?

There are a lot of misleading headlines out there.  Last week, the one that stuck out to us suggested that private credit and direct lending were slowing.  While that may technically be true, private credit is accelerating as a percentage of total deal activity, and that trend is very likely to continue.  In fact, if we look into the financing of most major private market deals right now, nearly all of them are financed by private lenders and NOT regional banks.  

The other notable condition of the current environment is that large deals are just not on the table.  The reason for this is multifaceted, but the most obvious reason is that it’s really difficult to find debt financing right now.  It is also very difficult to find larger deals that justify big, fixed charges against the business. 

Lenders often use the “Fixed Charge Coverage Ratio” as a barometer and loan covenant.  With interest rates way up, this number has fallen off a cliff.  PitchBook even suggests that approximately 45% of private companies with leverage have a FCCR below 1x.  While this condition can persist for short bursts of time, this ultimately suggests that these companies cannot service their debt and will need help/forgiveness from their lender if the business is to survive.  

We bring this up because there are a couple of things we’ve mentioned before that need revisiting.  First, when credit is super tight, the hurdle required to gain access is higher.  The companies that can clear this hurdle are generally going to thrive when lending conditions loosen. 

So, we continue to believe that the 2023 and 2024 vintage of private equity companies will be very strong.  And second, when companies are in this kind of trouble, the economy will ultimately feel stress.  We’re seeing media outlets call for a soft landing or suggesting that there are no signs of a recession, but when we look beyond the headlines, we find data like these that suggests that we might be there already.

Source:  PitchBook