All is calm, but it’s time to stay alert

Many in private markets seem content with market conditions, but it wouldn’t take much for a temporary wobble to become a longer-lasting problem.

Mid-market lenders are bullish about the current environment, and it’s not hard to understand why.

The US economy created 263,000 new jobs in April and unemployment fell to a low not seen in almost five decades. Consumers are getting paid more, and despite wage pressure, mid-market companies are performing well.

Many lenders and other financiers in the private markets say they can’t see anything that would cause a recession – which is precisely the problem. A healthy dose of scepticism is required at this precise moment, when many say they can’t see the catalyst that would lead to troubled times.

The annual InterGrowth conference – a large gathering of mid-market private equity firms, lenders and advisors sponsored by the Association for Corporate Growth – once again boasted thousands of attendees and provided a fresh look at the type of behaviour that could come back to haunt lenders.

Small-cap companies, say with $5 million of EBITDA, are attracting the same pricing as those in the lower mid-market, for example with $15 million of EBITDA. Who knows how much of that metric comes from addbacks? Mid-market lenders now argue about how much EBITDA credit to give borrowers for new locations rather than whether to include them at all.

The topsy-turvy nature of markets results in occasional tremors, as we experienced at both the beginning and end of last year. Those were more technical in nature, rather than fundamental – relatively positive economic figures meant that what happened in the stock market and in the syndicated loan market was counterintuitive.

But how prolonged need a market wobble be before it transitions from technical to fundamental? How long before credit markets freeze up? An executive at a large credit manager noted there was a moment in the fourth quarter when it was an open question as to how loans would be settled.

Credit managers of all stripes assert that when the going gets tough, it’s their moment to step into the spotlight and deliver. With locked-up capital, they are relatively immune from capital markets in the way other financial institutions may not be; they can assume the mantle of lenders of last resort.

That may be true, but private credit is an asset class relatively untested, at least on the scale at which it operates now. One thing that lenders are not immune to are the broader economic trends affecting their portfolio companies, and the way in which loose loan documents with flexible or no covenants could prompt lenders to try to salvage a business where real value has already been lost.

You could argue that it’s premature to make predictions. After all, there’s nothing distinguishable between being too early and being wrong, or so the saying goes. But lending is not akin to the game of economic forecasting. Decisions made now are ones lenders will have to live with in the years to come – for better or worse.

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