Private credit firms reduce margins to win large deals

Private credit funds are becoming more aggressive in their efforts to secure large deals. As competition rises, these firms are accepting smaller profit margins and increasing leverage to attract borrowers. This shift comes as overall deal activity has decreased. Credit spreads for top borrowers have reached low levels. In the U.S., private loans are now pricing at about 4.5 percentage points over the secured overnight financing rate (SOFR). In Europe, they are at 4.75 percentage points over Euribor. Hopes for a surge in mergers and acquisitions under the current administration have not yet materialized, impacting deal flow. Matt Douglass, CEO of PGIM Private Capital, noted that private credit managers are increasingly replacing bank finance, particularly for larger, higher-leverage credits. For example, Ares Management Corp. recently provided $2.2 billion in debt to support Clearlake Capital Group's acquisition of Modernizing Medicine. This financing was secured at a competitive rate while maintaining high leverage. The market has seen a significant decrease in average lending spreads. In March 2023, lending spreads peaked at 675 basis points above SOFR. By January 2025, they fell to around 500 basis points. To remain competitive, private credit lenders are willing to offer more favorable terms. This includes accepting higher leverage ratios and relaxed earnings definitions, often stretching to eight or ten times debt-to-earnings. Despite improving deal flow, it remains below average. Bill Sacher from Adams Street Partners pointed out the ongoing supply and demand imbalance. Companies that previously secured loans are now exploring cheaper refinancing options with banks, as many private credit contracts are less favorable than current market rates. Concerns about tariffs and geopolitical risks have impacted the leveraged-loan market, allowing private credit lenders to take the lead on large loans. In recent weeks, several deals were pulled from the syndicated markets due to this uncertainty. This situation is advantageous for private lenders who can offer more attractive financing options. Overall, the private credit sector is seen as responsive to market changes. Firms are leveraging their abilities to provide capital where traditional banks might hesitate. They face pressure to deploy capital effectively, resulting in a focus on larger and potentially riskier deals.