(Bloomberg) — For years, as private lending exploded into a $1.7 trillion industry, the line from the market's biggest players was that their deals were, simply put, safer.
Certainly safer than the high-yield bond market and also safer than the leveraged loan market, where struggling companies can take advantage of weak investor guarantees and join hedge funds to restructuring aggressively their debt at the expense of existing creditors.
It may still be so. Agreement documents are generally tighter in private loans; loans are financed by smaller “clubs” of lenders with deeper ties to companies and their private equity owners; creditors usually hold the debt until maturity. It all works to mitigate risk for investors, industry advocates say.
And yet, private lending is now enjoying what happens when things turn ugly.
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In recent weeks a technology learning platform backed by Vista Equity Partners displaced assets away from its lenders as part of a move to raise $50 million in new financing, according to people with knowledge of the situation. For many on Wall Street, the fact that private credit is not immune to such questionable maneuvers has been an eye-opener.
It's happening because higher interest rates are doing it more difficult for many companies to service their debt. All the while, lenders are flush with cash and dealing with limited investment opportunities depreciation each other in unusual prices and offers friendly conditions for borrowers while trying to put money to work.
Some warn that it is laying the groundwork for further pain down the road. Just last week the CEO of JPMorgan Chase & Co. Jamie Dimon said he expects problems to emerge in private lending and warned that “there may be hell to pay.“
One of the biggest selling points of private lending has been the idea that lenders aren't making the same kind of quick, cheap loans that Wall Street banks have been involved in over the years. And yet they are now facing similar problems that have plagued leveraged loan investors.
Vista acquired Pluralsight Inc., a technology workforce development company, in 2021 for about $3.5 billion. The leveraged buyout was supported by over $1 billion in debt financing from direct lenders.
In the years since, borrowing costs have risen, pushing the company's debt ratio to high levels. digit. Vista recently wrote off all of its investment capital, people familiar with the situation said.
In an effort to make a $50 million interest payment, the company moved the intellectual property to a new subsidiary and used those assets to obtain additional financing from Vista, the people said. The new loan weakens existing lenders' claims against IP, they added.
Pluralsight's lender representatives including Blue Owl Capital Inc., Ares Management Corp., Oaktree Capital Management and BlackRock Inc. declined to comment, while Goldman Sachs Asset Management, Golub Capital and Benefit Street Partners did not respond to requests for comment. Vista declined to comment, while a Pluralsight spokesperson did not respond to requests for comment.
Read more: Vista-backed tech firm divests assets from private lenders
The move is reminiscent of one of the earliest and most infamous examples of foreclosure: the J. Crew Group case. The company used loopholes in loan documents that allowed it to transfer intellectual property away from existing lenders to secure new financing. Other struggling companies owned by private equity funds — including Neiman Marcus, Petsmart and Envision Healthcare Corp. – have used similar asset moves in recent years to restructure their debt and avoid bankruptcy.
However, there are key differences between Vista's maneuver and other arrangements.
For one, IP was placed in a limited subsidiary that is still bound by the covenants of the original loan, the people said. In more aggressive liability management exercises, assets are usually dumped into an unrestricted subsidiary, which is not subject to these restrictions and is completely beyond the reach of existing creditors.
Vista also did not try to pit creditors against each other through a distressed debt swap, a tactic that unlimited subsidiaries have been used to support in the past. However, several lenders have engaged Centerview Partners and Davis Polk & Wardwell to advise on the situation, while Pluralsight is taking advice from law firms Kirkland & Ellis and Ducera Partners, the people said.
Centerview declined to comment, while representatives for Davis Polk, Kirkland & Ellis and Ducera did not respond to requests for comment.
Further debt negotiations between the company and lenders are underway, the people added.
“Some sponsors will be more reluctant than others to do this, but if it avoids a bankruptcy filing or court settlement, it's something to consider,” he said. Nick Caropartner in Goodwin's business law department and member of the private equity and debt financing groups.
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Industry observers expressed concern that Vista could displace additional intellectual property from lenders.
More broadly, amid concerns of further stress in private credit, Vista's move sets a dangerous precedent, said Sheel Patel, a partner in the private credit and special situations group at King & Spalding.
The firm could have injected more money into Pluralsight through an equity investment. Instead, it chose to do so in exchange for a claim on some of the company's most valuable assets.
“People will look at this and say, 'why would I put dollars in equity when I could put dollars in senior debt and improve my recovery,'” Patel said. “You will see more and more sponsors solving the liquidity issues of portfolio companies in this way, rather than using capital injections or small equity.”
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Regardless, few see a wave of controversial debt transactions sweeping the private credit landscape anytime soon.
Market participants say that governing documents in private credit are still, in general, more protective of lenders' interests than those in public markets.
“I don't think this is the beginning of a lender-to-lender violence in private loans,” said Joseph Weissglass, a managing director at Configure Partners. “That said, there is an increased probability as private credit capital structures become larger and collateral and organizational structures more complex.”
Others say that seeking more money after the limited supply of deals will inevitably lead to questionable results.
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“We've seen some financing deals in the private markets involving riskier capital structures that would probably have struggled to pull off in the public markets,” said Sachin Khajuria, who runs family office firm Achilles Management and invests in private assets. “Because they're private, if problems arise, they may not be as obvious until it's too late.”
Elsewhere in the credit markets: