The mid-market continues to attract private debt investors as the Fed cuts interest rates. Could this fuel the economy and rev up the deal market, or are we nearing the end of the credit cycle? Eric Lloyd recently weighed in with a panel of experts for PDI.
Let’s start with the age-old question: Where do you think we are in the credit cycle, and what could be the catalyst for a downturn?
We’ve been saying we’re in the seventh inning for a while. Now with the Federal Reserve rate cut it appears we’re in a rain delay, so this cycle could go on for a while. That eliminates higher rates as a catalyst for a downturn—at least for now—which leaves trade issues as the most visible market worry.
We are very late in the cycle. This is the longest-running recovery in economic history in this country. I think the question is what will tip this cycle, which is really unknown. International tariffs and the exchange rate environment—those are external global factors. An internal factor is a growing dynamic between the politicization of the Federal Reserve by the executive branch. That’s concerning.
What are conditions like in the deal market?
The competition is fierce. And it’s not just leverage and pricing, but documentation terms and other things. In market conditions like the ones we’re seeing now, the scale of a manager’s platform really matters.
We think it’s critical to have large, well-resourced teams in place to underwrite transactions, work through challenging situations and prudently manage portfolios. It’s also important to be able to provide capital solutions that are flexible and that meet the needs of sponsors and borrowers as market conditions evolve.
We see some examples of loosening provisions in loan documentation. For example, the definition of EBITDA used to be very clear. Now, when you search for the legal definition of EBITDA within a loan and security agreement, the definition could be five paragraphs, maybe a whole page. Similarly, many companies today can add leverage on property, plant and equipment that’s separate from just your cash flows.
The key in approaching deals in a market like this is to be commercial and competitive, but with a laser focus on what will matter most in a workout or restructuring. It’s important to focus on conditions relating to any leakage, by way of restricted payments or investments, on the borrower’s ability to incur additional debt, whether it is junior debt or pari.
Conditions remain very constructive. Yes, there are fundamental credit concerns, like higher leverage. Those are medium- or longer-term issues. They’ll become real when the economy hits a bump or anything that creates hurdles for issuers trying to make pro forma adjustments work. Otherwise you’re looking at a very different credit than what you signed up for.