Private Debt News Issue #10: Rising Default Risks, Strategic Moves, and Mega-Deals (4.28.24)

From JPMorgan's Warning on Problem Loans to Blue Owl's £1.2 Billion Audiotonix Deal – The Shifting Landscape of Private Credit

The private credit market continues to navigate a complex terrain marked by mounting concerns over default risks, strategic shifts among major players, and a steady stream of mega-deals. This week's Private Debt News examines the latest developments shaping the $1.7 trillion industry, from JPMorgan's cautionary note on rising stress in the market to Blue Owl's £1.2 billion debt package for the acquisition of Audiotonix.

1. JPMorgan Sees Rising Default Risk in the Private Credit Market

JPMorgan Chase's asset management group has sounded the alarm on increasing stress in the private credit market, warning that default rates could rise despite only a modest uptick in the past two years. The report, published on April 15, highlights the deterioration of interest coverage ratios as borrowing costs climbed to multi-decade highs in August 2023, signaling greater difficulty for borrowers in servicing their debt obligations.

The rapid expansion of the private credit market since the financial crisis has attracted major fund managers, but the increasingly crowded space has also led some sponsors to take on riskier borrowers in pursuit of higher returns and differentiation. As the effects of the Federal Reserve's tightening policy continue to ripple through the market, JPMorgan predicts a rise in leveraged loan defaults to 9.6% in 2025, up from 5.6% at the end of 2023.

The warning from JPMorgan underscores the growing concerns among market participants and regulators about the potential vulnerabilities in the private credit sector, particularly as the asset class navigates its first prolonged period of stress since its recent phase of explosive growth.

2. TGI Fridays Mulls Options to Repay Franchise-Backed Bonds

TGI Fridays, the iconic restaurant chain, is exploring options to address its debt obligations as it grapples with weakening sales. The company has been working with Guggenheim Partners to find solutions, including the potential for a new private loan to refinance its $375 million asset-backed bonds, which were structured as a whole-business securitization.

The move by TGI Fridays highlights the challenges faced by companies that have borrowed against their assets as collateral, particularly in sectors hit hard by the pandemic and the subsequent economic uncertainty. As the anticipated repayment date for the company's bonds approaches in April, the search for alternative financing options reflects the growing role of private credit in providing liquidity and flexibility to borrowers in need.

However, the TGI Fridays case also serves as a reminder of the complexities and risks associated with asset-backed financing, especially when the underlying assets may not have clear maturity dates or easily ascertainable values.

3. Tor Investment Raises $310 Million for Asia Private Credit Fund

Hong Kong-based alternative credit manager Tor Investment Management has successfully raised $310 million for its third Asia opportunistic private credit fund, seeking to capitalize on the growing popularity of the asset class in the region. The fund targets deal sizes between $50 million and $150 million, a range that is often underserved by larger funds and local lenders.

The successful fundraising by Tor Investment underscores the increasing appetite for private credit opportunities in Asia, where the market share of assets remains a fraction of the global total but the growth rate has outpaced that of other regions. As investors seek attractive risk-adjusted returns in a low-yield environment, private credit managers with the expertise and agility to navigate the diverse legal and regulatory landscapes of Asian markets are well-positioned to capture this demand.

However, the rapid growth of private credit in Asia also raises questions about the potential risks and challenges that may arise as the market matures, including the need for robust due diligence, risk management, and investor protection frameworks.

4. Private Credit Lenders Mull Financing for Goodyear Asset Sale

Private credit firms are considering providing financing for Goodyear Tire & Rubber Co.'s potential sale of its off-road business, with a debt package expected to be in the range of $300 million to $400 million, or roughly three times leverage. The move comes as part of Goodyear's broader strategic overhaul, which has been fueled by pressure from activist investor Elliott Investment Management.

The interest from private credit lenders in financing the Goodyear asset sale underscores the continued appeal of the asset class in supporting corporate carve-outs and divestitures, particularly in sectors undergoing significant transformation or facing industry-specific challenges. As traditional bank financing remains constrained and borrowers seek more flexible and bespoke solutions, private credit funds with the sector expertise and structuring capabilities are well-positioned to step in and fill the gap.

However, the competitive landscape for private credit deals remains intense, with direct lenders facing increased pressure from Wall Street rivals looking to reclaim market share in the leveraged finance space.

5. EQT's Avetta Buyout to Get One of the Cheapest Private Loans

EQT AB has secured one of the most competitive financing packages in the private credit market for its acquisition of Avetta LLC, with a group of direct lenders providing around $1 billion of debt at a rate of just 4.5 percentage points over the benchmark. The pricing represents a significant 1.25 percentage point reduction compared to Avetta's existing credit facility, which was put in place just six months ago.

The aggressive pricing of the Avetta deal reflects the intense competition between private credit firms and Wall Street banks in the current market environment, as a scarcity of new leveraged buyouts has left direct lenders scrambling for attractive opportunities to deploy capital. To avoid losing ground to institutional investors in the leveraged loan market, private credit funds have been increasingly willing to slash prices and offer more borrower-friendly terms on high-profile transactions.

While the Avetta financing represents a win for EQT and a testament to the strength of the private credit market, it also raises questions about the sustainability of such pricing levels and the potential risks associated with the erosion of lender protections in the face of intense competition.

6. Secondhand Private Credit Sets Up $15 Billion of Early Exits

The private credit secondary market is poised for significant growth in 2023, with as much as $15 billion in portfolio sales expected to close this year, according to a survey by Ely Place Partners Ltd. The projected volume represents a threefold increase from the reported deals closed in each of the previous two years, highlighting the growing demand for liquidity solutions in the private credit space.

The rise of the secondary market is being driven by a combination of factors, including the need for investors to manage their liquidity in the face of slower distributions from private equity funds and the desire of private credit managers to recycle capital and generate additional fee income. Major players such as Apollo Global Management Inc., Ares Management Corp., and Allianz SE have already lined up billions of dollars for strategies focused on acquiring stakes in private credit funds at discounted prices.

The growth of the secondary market represents a significant development for the private credit industry, providing a potential solution to the liquidity challenges that have long been a concern for investors and regulators alike. As the market matures and becomes more established, it is likely to attract a wider range of participants and drive further innovation in the structuring and pricing of secondary transactions.

7. Franklin Templeton's Quiet Emergence as a Major Force in Private Markets

Franklin Templeton, a stalwart of traditional asset management, has undergone a remarkable transformation in recent years, quietly becoming a significant player in the private markets space. Through a series of strategic acquisitions, including the purchase of private credit manager Benefit Street Partners and European credit specialist Alcentra, the firm has amassed over $260 billion in alternative assets under management.

The shift towards private markets reflects Franklin Templeton's recognition of the changing investment landscape and the growing demand from investors for exposure to alternative asset classes. By leveraging its extensive retail distribution network and long-standing relationships with financial advisors, the firm aims to democratize access to private market strategies and capture a larger share of the rapidly growing market.

However, the success of Franklin Templeton's private markets push will depend on its ability to navigate the challenges of integrating acquired firms, maintaining investment discipline, and delivering consistent performance in an increasingly competitive environment. As more traditional asset managers seek to establish a presence in the private markets, differentiation through specialization, scale, and value creation will become increasingly important.

8. JPMorgan Mulls Two Synthetic Risk Transfers as Market Heats Up

JPMorgan Chase & Co. is exploring the issuance of two synthetic risk transfer (SRT) deals totaling approximately $2 billion, as the bank prepares for the implementation of more stringent capital requirements under the upcoming Basel III Endgame rules. The transactions, which are expected to hit the market in the fourth quarter of 2023, will likely include at least one deal tied to a portfolio of corporate debt.

The move by JPMorgan reflects the growing popularity of SRTs among major US banks as a tool for managing regulatory capital and transferring credit risk to institutional investors. By issuing notes linked to a pool of loans and including a credit derivative, banks can effectively shift a portion of their credit exposure off their balance sheets, freeing up capital for other purposes.

As the SRT market continues to gain momentum, driven by the anticipation of more onerous capital rules and the appetite of yield-seeking investors, the scale and structure of these transactions will be closely watched by market participants and regulators alike. While SRTs offer a potentially valuable tool for banks to optimize their capital positions, concerns remain about the transparency and complexity of these instruments and their implications for financial stability.

Conclusion

This week's Private Debt News paints a picture of a private credit market grappling with a range of challenges and opportunities, from the specter of rising default risks to the allure of mega-deals and the emergence of new strategic players.

As the industry continues to mature and evolve, participants will need to navigate an increasingly complex and competitive landscape, balancing the pursuit of growth and returns with the imperative of sound risk management and investor protection. The development of new markets, such as the secondary space for private credit, and the entry of traditional asset managers like Franklin Templeton, underscore the dynamism and innovation that continue to drive the sector forward.

At the same time, the warnings from JPMorgan and others about the potential vulnerabilities in the market serve as a reminder of the need for vigilance and discipline in the face of rapid growth and changing market conditions. As the private credit industry charts its course through an uncertain economic and regulatory environment, the ability to adapt, innovate, and maintain a long-term perspective will be critical to its continued success.