While it appears that deal flow is taking a pause in the private credit arena given headlines and market dynamics, pockets of activity do exist, and frustrated LPs may be turning to the non-sponsored market to find alpha.
To be sure, in the competitive sponsor-backed market, spreads have become increasingly tight and now are normalizing in the S+500-525 area, according to market sources. What’s more, oversaturation in some sectors has also given investors pause, leading them to look for new avenues of opportunity.
“The LP community is disappointed that core lending in their books has underperformed and that they’re overexposed to software and SaaS,” said Mustafa Humayun, partner and portfolio manager at Sagard Credit Partners. “They are frustrated and are looking for alpha in credit.”
Cue the non-sponsored market, which is historically not as competitive as the sponsor-backed market.
As such, those types of deals are hard to find, which may be why there’s more upside, sources say.
“The non-sponsored market is a less crowded game,” said Andrew Korz, senior vice president, investment research at Future Standard. “You’re not relying on PE sponsors to do the underwriting. From an asset manager perspective it can be more resource-intensive, but that can potentially lead to higher returns.”
Non-sponsored deals may be more complex, but as a result they can come with greater lender protections, such as personal guarantees from the company founder or owner, according to Korz. “Generally speaking, covenants tend to be more bespoke in non-sponsored transactions,” he said.
Many of the deals in non-sponsored market are founder- and family-owned and the retiring, and aging baby boomer generation is part of the reason there may be more deals coming to market currently, as those businesses are being put up for sale.
As well, many of the types of businesses that are entrepreneur-founded are “old school,” such as manufacturing, business services and consumer products, and therefore are not cyclical or subject to other broader market setbacks.
Yet, there are some trade-offs.
You don’t have the sponsor to make sure things are going well so it’s all hands on deck if things go wrong, Korz noted. “You’ve got to get in there to maximize the value of the loan,” he said.
Another pain point is the length of time it can take for deals to get done. “It may take three to five months to put together a transaction and close, whereas in the sponsor world it may take only a week or two,” said Sagard’s Humayun. “Lenders to non-sponsored companies have to earn their spread,” he said.
While pricing is determined on a case-by-case basis, the non-sponsored market typically comes with anywhere from 100bps to 300bps of extra spread to the sponsored market.
“It’s negotiated,” said Humayun. “Sometimes the spread comes in excess coupon or OID, or through heavy prepayment premiums.”
Krista Giovacco
krista.giovacco@levfininsights.com
+1 917 757 6399
