What should be a creditor’s prime concern right now? Credit quality? Secured overnight funding rates? Recession? They don’t appear to know.

In early March, financial marketplace CAPX published the results of a survey on the attitudes of lenders (both private debt funds and banks) towards deal activity and credit in the first half of 2023. The most striking finding is the absence of any firm consensus.

There were roughly 60 respondents to the survey, and of those more than half were on the direct lending side of the mix.

Respondents generally agreed in expecting a slowdown in leveraged buyout and M&A activity. Beyond that, banks are more concerned about borrower credit quality than direct lenders. The direct lenders, on the other hand, are more concerned about the impact of SOFR on yields.

Banks split evenly on how the first half of this year will compare with the second half of last year. Half expect fewer deals and fewer closings, the other half exactly the opposite.

Default divide

One fascinating data point: when lenders were asked to rank on a one to 10 scale the likelihood of an increase in defaults, the market sharply bifurcates. There were no votes for one or two, but over 24 percent of lenders (including both sides of the bank/direct lending divide) said either three or four, answers still on the optimistic half of the continuum. There were only a few who answered five, and plenty of answers – unsurprisingly – were above five, on the pessimistic half.

But why were there as many optimists as there were? Rocky Gor, founder of CAPX and former managing director of Wells Fargo Capital Finance, says: “From the lenders’ perspective the point is that the private equity firms have put a lot of money into the operating companies so they are not going to just let them default, they will work with their lenders.”

Aside from such micro considerations, there is the macroeconomic possibility that the first half of this year will be one of growth. After all, only less than 2 percent of respondents said that an unemployment-driven recession is their top concern about the new year. The same number said that the possibility of rising interest rates hurting the fixed charge coverage ratio is their top concern.

The CAPX report points out that if the first half is a time of growth, as a consequence there is no rash of defaults that will have an important consequence for the banks. Their deal activity, it says, “will likely whipsaw, as many are sitting on large pools of capital that they want to put to work”.

Will this mean that the banks, in trying to use their excess of dry powder, will end up coming into competition with the direct lenders? In the interview, Gor reasons that banks “are not going to go into head-to-head competition with the debt funds: banks are still heavily regulated institutions, and they cannot take credit risks accepted by debt funds”.