(Bloomberg) -- Returns from direct lenders beat their private equity counterparts in the second quarter, according to data compiled by State Street Corp., even as the easing of monetary policy by central banks looks set to dent the advantage.
“I expect the private debt outperformance will begin” reversing after the Federal Reserve began cutting interest rates, said Nan Zhang, head of product implementation and alternative investment research at the asset manager. “Private debt, especially floating-rate debt, typically benefits from rising interest rates.”
Looser credit conditions will begin to free up private equity’s ability to do deals again after a failure to hedge against rising borrowing costs gummed up the financial machine that fuels the industry. Lower credit costs should also ease the pressure on many portfolio firms, some of which added expensive leverage when exits became difficult at valuations demanded by managers.
The hedging snafu helped private credit outperform buyout funds in seven of the last 10 quarters. That’s in part because direct lenders usually offer floating rate debt and can collect regular interest payments. Private debt posted returns of 2.18% in the second quarter, according to the State Street Private Equity Index, while buyout vehicles delivered just 1.47%.
The returns from lending are also attractive compared with the wider credit universe, where an inflow of cash from insurers and pension plans eager to lock in high returns caused the extra yield over government bonds to tighten.
“Even as public market spreads have come in, we have been able to earn double-digit returns in senior credit strategies across both corporate and asset-backed finance year-to-date, using our scale and structuring capabilities to originate assets that offer excess return,” said Tristram Leach, co-head of European credit at Apollo Global Management Inc.
Lower Defaults
To be sure, direct lenders will benefit in some ways from lower interest rates. The falling cost of borrowing helps struggling debtors pay their debts, lowering the risk of defaults.
“Higher interest rates have been an impediment to the performance of many of the underlying assets in private credit,” primarily the leveraged buyout portfolios of business development companies, said Christina Padgett, head of leveraged finance and private credit research at Moody’s Ratings.
“Lower rates will be supportive of cash flow generation of LBOs and their valuations. Lower rates are also likely to support fund raising as investors reach for yield,” she said.
Rate Cuts
PE firms should also find it easier to raise money as interest rate decline. The Bank of England, for example, reduced its benchmark by 0.25% on Thursday, though Governor Andrew Bailey cautioned the institution can’t cut too quickly or by too much.
“Despite private debt’s recent outperformance, investors continue to invest in private equity for its higher long-term return potential and diversification benefits,” Zhang said.
Still, the State Street report forecasts that 2024 fundraising by PE will decline again this year to $358.6 billion.
More Disposals
PE firms have struggled for much of the past 18 months to monetize assets amid a semi-functioning market for initial public offerings and an M&A market marked by a gap between what sellers want and buyers are willing to pay.
Now, there are some early signs that PE managers are cranking up the Wall Street machine again. Stada Arzneimittel AG’s owners Bain Capital and Cinven for example have opted for a foray into the anemic IPO market, Bloomberg previously reported.
The strength of the economy is also convincing some alternative asset managers it’s time to start putting their dry powder to work, which will also throw up opportunities for private credit providers. Private equity firms have been involved in at least $175 billion of listed company takeovers globally this year, up 81% from the same period in 2023, according to data compiled by Bloomberg.
Deals
Blue Owl Capital Inc. was the joint lead arranger of a $2.175 billion private credit deal for Stone Point Capital-backed human resources software platform Vensure Employer Solutions Inc.
Sixth Street is the leading lender in a debt package of around €420 million for Blackstone’s purchase of Luxembourg-based Seves Group
Shanghai DC-Science Co., a Chinese data center developer and operator, is seeking private debt of about $600 million to $700 million to fund a project in southern Malaysia
HPS Investment Partners LLC is leading a group of lenders providing about ￡800 million of private credit to Ocorian Ltd., an investment management business backed by Inflexion Plc
GoldenTree Asset Management agreed to buy a portfolio equivalent to about €800 million of UK consumer loans from Bank of Ireland Group Plc
International Schools Partnership is in talks with direct lenders to borrow as much as ￡700 million through a private credit acquisition loan
Fundraising
BlackRock Inc. is setting up a private credit loan fund that will allow it to raise as much as $1.3 billion it can distribute to existing investors
Barings LLC has raised A$230 million ($151 million) for its first Australian private debt fund from a global investor to provide loans to mid-market Australian and New Zealand companies
Job Moves
Maximilien Pucci-Sisti Maisonrouge joined Katten Muchin Rosenman as a partner in its private credit practice in New York
Rachel Gray joined Paul Hastings as finance partner in New York to work with private equity firms, portfolio and other companies, mid-tier lenders, bulge-bracket banks and direct lenders across finance transactions
Did You Miss?
Apollo’s Race Toward Private-Credit ETFs to Face SEC Scrutiny
Ares Grows Cash Pool as Demand for Private Lending Soars
Allianz X and AlTi Tiedemann Join Up to Cater for the Ultra Rich
Private Credit Metrics Near Trough with Rate Cuts, KBRA Says
Sidley’s London Recruits From Latham See Private Credit Opening
Troubles Are Coming for the Private Credit Industry: The Brink
Private Credit Lenders Chase Growth in Australia Real Estate
Blue Owl Co-CEO Draws Line Between Public, Private Markets
--With assistance from Ben Scent and Bella Farr.
(Updates to add BOE rate cut in first paragraph below Rate Cuts subheadline. An earlier version of this story was corrected to change the forecast for PE fundraising this year)
