Low interest rates should not be the only consideration, especially in an unpredictable business environment
A US private credit manager has warned that intense competition is driving down rates and loosening other credit terms to the extent that it is increasing risk in the sector.
Kunal Shah, Co-Head of Origination at Brightwood Capital, said: “During the past couple years, there has been an influx of capital allocated to private credit managers.”
This has created a fundamental problem within the sector, according to Shah. “What has unfolded is a race to the bottom. Many private credit firms with an influx of additional capital have gone further upmarket, targeting larger sponsors and competing against each other for a limited amount of sizeable deals.”
He added firms are not just competing on rates but also on loosening other credit terms. “They are competing by providing wider financial covenants – or no financial covenants – and providing other flexibility that can lead to more cash leakage and the ability to move assets or intellectual property out of a company,” he said.
This intense competition emerged partly due to an increased number of private credit managers providing proposals, enabling firms to bid them off against each other. “Quite often, the one with the lowest rate and the looser credit terms wins. Ultimately, there is a real potential risk to that,” he said.
Another reason this played out during the last few years is a “substantial” decline in annual M&A volume since 2021, he said. “With an influx of capital going into private credit and limited M&A activity, private credit managers are competing over a reduced supply of deals.”
He said that Brightwood’s consistent focus on being a value-added relationship lender to both sponsor and non-sponsor backed middle market companies has allowed them to better navigate the broader private credit market dynamics at play.
Economic headwinds
The US economy is entering a period of uncertainty, with radical changes to government spending programmes and trade tariff arrangements. However, investors can protect themselves by investing in private credit funds that have a disciplined approach to lending, according to Shah.
He said: “When we think about tariffs, inflation or turmoil across the globe, when you are only lending on average up to 50% loan to value, it allows a significant cushion to navigate through increased costs or uncertainty.”
Brightwood has approximately $6 billion assets under management, primarily floating-rate direct lending to US-based middle market companies, with a strategy to lend to both sponsored and non-sponsored companies.
While he acknowledges that no portfolio is immune, he said exercising caution when dealing with companies that are more susceptible to government spending or tariffs is important.
Investors can also take some comfort from the fact that President Trump has historically focused on the stock market and economy as big indicators of success. “While there is going to be volatility along the way, the economy is something that Trump has historically taken under consideration when he is contemplating tax reform, government spending or tariffs.”