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Credit ratings agency Moody’s has warned of a “race to the bottom” between banks and private credit funds financing risky leveraged buyouts, which it believes will increase systemic risks across the U.S. financial system.
The ratings agency said on Thursday that renewed interest from banks in lending for such deals, as well as tougher competition from the fast-growing private debt sector, could lead to more capital flows at a time when overall economic conditions are deteriorating. Lower quality deal.
“We believe the large banks in the publicly syndicated loan market have taken a significant share of leveraged loans in recent years as new leveraged buyouts emerge,” said Moody’s analyst Christina Padgett, who leads the agency’s research. lost to private credit rivals, so they will compete fiercely.” Risky business loans.
“This will lead to a decline in pricing, terms and credit quality, exacerbating systemic risks.”
The warning from one of the largest U.S. credit ratings agencies comes as the private equity industry slowly begins to find its feet after the Federal Reserve sharply raised interest rates last year, rocking financial markets and sharply weakening trading.
But as market volatility and fears of a coming recession recede, the buyout shop is once again looking for elephant-sized deals. As a result, bankers and private credit executives told the Financial Times that they have seen an increase in calls to lend to the sector in recent months.
Over the past two years, many private equity firms have turned to the $1.5 trillion private credit industry to finance their deals. These include Thoma Bravo, which tapped private lenders to fund its $8 billion acquisition of business software provider Coupa Software; Hellman & Friedman and Permira, which signed about $5 billion in loans from creditors led by Blackstone to cover its $102 US$100 million to acquire business software provider Coupa Software. Software maker Zendesk.
Banks, which lost out on lucrative fees for underwriting takeovers, looked to get back into the business they had long dominated. Private credit funds are also facing greater competition as they increasingly offer services that were once solely the purview of banks, such as revolving credit facilities to businesses.
To be sure, private equity deals remain sluggish, and banks have so far been mostly conservative in the acquisitions they ultimately agree to finance.
Many of Wall Street’s biggest banks are only slowly starting to get back into the market after a painful 2022, when they held shares with software maker Citrix, TV ratings provider Nielsen, auto parts maker Tenneco and social media company X High-risk leveraged buyout-related loans. , formerly known as Twitter.
Banks such as Bank of America, Barclays, Credit Suisse and Goldman Sachs ended up selling the debt to other investors, collectively losing billions of dollars. Lenders to Elon Musk, which bought X last year, have so far been unable to sell debt related to the deal.
But their appetite has begun to return as loan market prices rebound and fund managers rush to buy lower-rated corporate bonds and loans. Part of the price rebound is due to a sharp decline in loan issuance, with new high-yield debt issuance (excluding refinancing activity) at its second-lowest annual level since the onset of the 2008 financial crisis. London Stock Exchange Group.
“In an already weak economic environment, any ‘race to the bottom’ around leveraged buyout terms and pricing will have broader systemic risk implications,” Padgett added. “At the same time, increasing parts of the riskier leveraged loan market are being drawn into private credit, beyond the purview of prudential regulators.”
She added: “Competition among lenders is likely to intensify just as private credit faces its first real test in an environment of sharply rising interest rates.”
Additional reporting by Harriet Clarfelt in London
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