Private credit firms are set to play a much bigger role in the way investment-grade companies raise capital than ever before. After practically remaking leveraged finance, direct lenders are beginning to shake up high-grade, and big changes are afoot.

The potentially multi-trillion US dollar market for investing in high-grade companies and their capital-intensive projects is expected to take the form of financing structures like privately placed bonds, asset-backed securities and hybrid formats that are typically unavailable in public forums. A main goal of these vehicles is to allow companies to spend massively without diluting equity or lowering high corporate ratings, with capital needs for some sectors being greater than they have ever been.

But the economics will have to make sense. Direct lenders typically seek double-digit returns, which bankers say will only be possible in investment grade by deploying leverage or providing funding to higher-yielding parts of the capital structure.

Ideal targets for this growing pool of private capital include power companies looking to fund the transition to clean energy and tech firms needing to finance asset-heavy infrastructure to keep up with advancing artificial intelligence technology. Joint ventures announced last year between Blackstone and EQT, and Apollo Global Management and Intel – and specifically the hybrid financing packages that fund them – are prime examples of what's in store.

“You have all of these high-multiple, asset-light companies, primarily in the technology sector, that need enormous computing power,” said a senior DCM banker. “But you don't want to sacrifice your multiple to start becoming a hard-asset, lower-growth, lower-margin [company].”

Intel, a linchpin in Joe Biden's administration’s plans to revive the US semiconductor industry, announced in June that Apollo will lead an US$11.23bn investment for a 49% stake in its Fab 34 chip wafer facility in Ireland. In the announcement of the “equity-like” investment, Intel pointed out that the deal structure allowed the California-based company to pursue its foundry plans while maintaining its “strong investment-grade credit rating”.

Equity-like

Borrowing that sum in the corporate bond or loan markets would have cut into Intel’s current Baa1/BBB/BBB+ ratings.

“There are elements that some of these private credit structures can offer that are so bespoke that they tick a number of boxes that the public markets are not currently set up to offer – or at least not in the size needed,” a second banker said, noting that such structures could include highly customised call features.

In a report last month, Apollo estimated that private credit represents a potential US$40trn market opportunity, based on the size of all the asset classes it can address, and it said most of that total is investment grade.

That challenges the prevailing idea that private credit is chiefly a concern for leveraged markets, where in the wake of the global financial crisis as banks licked their wounds, direct lenders stepped in to take big swathes of fundraisings that otherwise would have been sold through syndicate desks.

Dealmakers say there is more than enough business for both investment banks and private credit firms – often considered natural rivals in leveraged finance – to thrive as direct lenders and become a bigger part of the high-grade market. Corporate issuers like Intel and EQT, for example, are still going to tap the public bond markets for liquidity.

“I don’t view them as points of friction. The evolution of the private markets should prove additive as another layer of investment-grade issuance on a go-forward basis. There is unquestionably appetite and demand for it and, frankly, a scarcity of assets in what remains an incredibly bespoke segment of the market,” said Meghan Graper, global head of debt capital markets at Barclays.

Juiced returns

Banks will also have the potential to realise returns by providing private credit lenders with leverage. “We are giving them the leverage to jack up their returns,” said a senior investment-grade corporate DCM banker in London. “You can’t do a direct loan in investment grade and then get 11%-plus returns. But if you put leverage on, you could, though [the investment becomes] more risky."

Banks will toggle the amount of leverage they extend to specialised private credit funds based on the riskiness of their portfolios, but will generally provide funds at a leverage ratio between 1.5 and two, said Regina Gil, head of BBVA CIB in the US.

Nonetheless, well-established businesses with robust finances are expected to use predominantly public markets for the better execution on offer, especially when credit spreads are trading near post-financial crisis tights.

“For more regular-way financings, it remains far more advantageous for [investment-grade companies] to go to public markets in terms of the price efficiency that it currently affords them,” said Graper.

Indeed, public markets help juice the returns from private market investments. Major alternative asset managers such as Blackstone, Apollo and Ares Management use the public bond market to raise cheap funding. More broadly, business development companies, effectively lending vehicles for private credit, have recently sold billions of US dollars of high-grade senior unsecured notes at increasingly tight spreads.

“I think that you're going to continue to see the lines blurred between private and public,” said the first banker. “Certainly, you have some market participants talking about five years in the future there being no distinction in liquidity or portfolio holdings across public and private debt capital markets, particularly for investment grade.”

Additional reporting by Sudip Roy

Source: IFR