Private Credit Trends in the Middle Market

By: Ryan Crowell

Product Manager - Private Credit
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The ongoing COVID-19 pandemic has impacted virtually every corner of the world economy, and the Private Credit markets are no exception. Following a decade of near-continuous growth, both Direct Lending fundraising and deal flow have slowed as middle market M&A activity hit pause. Hoping to capitalize on the ongoing market dislocation, fund managers have launched new vehicles focused on Distressed Debt, Special Situations, and Opportunistic Credit strategies, with broad flexibility to chase value across asset classes. LPs have so far thrown their support behind these vehicles, with several marquee names adjusting their portfolio allocations to increase exposure to dislocation-focused strategies.

Impact on the Middle Market

Direct Lending has flourished over the last decade, driven by LP interest in floating-rate paper, and the perceived premium offered by the middle market relative to the BSL space. The Interagency Guidance on Leveraged Lending, issued by the OCC in 2013, acted as a catalyst, driving issuance away from banks and towards non-regulated entities. For many Direct Lenders who were launched after the Great Financial Crisis, the current recession represents their first true cycle. However, unlike past recessions, the resiliency of their portfolios has been tied largely to their exposure towards industries most impacted by the widespread lockdowns and social distancing orders. This includes industries that have historically been viewed as defensive, such as aerospace manufacturing and certain sub-segments of the healthcare sector that have been uniquely impacted by the circumstances of the current pandemic.

While a playbook quickly developed between Direct Lenders and Sponsors to provide relief to these temporarily impacted but otherwise strong portfolio companies through early 2021, typically through some combination of an equity infusion in exchange for a reduction in cash interest, a prolonged recessionary environment could test the patience of those stakeholders to extend these arrangements beyond the term of their agreement. Sponsors will be less likely to contribute additional equity outside of their strongest portfolio companies, and lenders may seek to exit their position rather than negotiate another extension. For dislocation-oriented fund strategies launched in the wake of the pandemic, these “fallen angels” could create a second wave of opportunities to invest in businesses with otherwise stable long-term prospects.

Opportunities for Dislocation-Oriented Investors

The current market dynamics have created opportunities for those investors with the capital and flexibility to fill the void left by both banks and traditional Direct Lenders. Middle market companies with strong underlying financials, or those that may be overleveraged due to current circumstances—that is, companies experiencing liquidity challenges due to economic conditions— will be prime targets for managers who wish to consider bespoke financing solutions. This is especially true for non-PE owned companies in the middle market who lack the institutional relationships that their larger, or Sponsor-backed peers have access to. For dislocation-oriented investors, gaining access and being able to quickly work through due diligence will be key to standing out against the wave of capital that is building to chase these opportunities.

Operational Implications for the Private Credit Market

Due to the rapid-fire nature of distressed and special situations investing, managers should expect to see increased competition for the most lucrative deals. With so much capital chasing a finite amount of high-quality deals, fund managers will need robust research capabilities to identify those diamonds in the rough and be prepared to make well-informed investment decisions quickly. This is especially true for distressed managers investing in active bankruptcies or restructurings, or opportunistic funds investing in the public credit markets.

As competition increases and the efficiency of dislocation-focused managers is tested, a lack of the proper tools, or worse, a dependence on Excel, will leave them disadvantaged in this dynamic and uncertain environment. Technology resources that provide support through the entire lifecycle of an investment, from sourcing to funding and through portfolio management, enable managers to quickly react to market opportunities and provide a streamlined real-time view of aggregated information across their portfolio.

Additionally, the uncertainty around the duration and severity of the pandemic has made it difficult for private credit fund managers of all types to analyze the impact to their portfolios at a time when they are under heighted levels of LP scrutiny. This is particularly pertinent to GP’s valuation processes, where reporting lags and the significant dislocation of the public markets, which serve as a reference point for private market valuations, have created acute challenges. For a market that has historically operated with limited transparency, the ability of private credit fund managers to provide insight into their portfolios is more important than ever before.

Fund managers need an all-in-one solution that provides powerful research tools, portfolio monitoring, flexible analysis resources, risk management, and exposure mapping to streamline their front office operations and position themselves for the best deployment opportunities. Tools that connect the front and back office, and support each investment through its entire lifecycle, are especially powerful for fund managers seeking to eliminate manual handoffs and connect disparate information sources.

Similarly, resources that allow LPs to better manage their alternative holdings, and help connect their systems to their GPs, can improve insights, streamline reporting, and reduce the man hours required to track performance. Allvue’s LP Portfolio Management solution was built specifically to account for the nuances of alternative assets, including both private equity and private credit.

About Allvue

Allvue offers a highly configurable, full-service suite of modules for the entire investment lifecycle. Funds can track and filter multiple prospects, letting them make quick decisions and stay ahead of the competition. With research management, comprehensive front- and back- office capabilities, and multi-asset coverage in a single instance, we provide mission critical software so fund managers can more efficiently track and analyze their portfolios. Allvue’s platforms are built to manage a diverse array of asset classes, including public and private credit, equity, derivatives, and asset-backed securities, providing GPs the flexibility they need to respond to shifting market dynamics and execute on their most promising opportunities.

For more information on Allvue’s multi-asset, front-to-back solution set for credit funds, request a demo.