Private Credit Enters the Equity Business as Borrowers Struggle

8d2[fc0b]hg[rdf)[zb22(dq_media_dl_1.png via Bloomberg

Article content

(Bloomberg) — Private credit firms are in the business of lending, not owning. But as more borrowers start to struggle with their liabilities, lenders are swapping their debt positions for equity stakes to try and stem losses.

Article content

There’s been a string of debt-for-equity swaps in recent weeks, including for British auction house Bonhams, telecommunications supplier Netceed, Italian sportswear maker Dainese and French radiology-center specialist Oradianse.

Article content

Article content

Article content

While these swaps can produce upside, the original investment was designed to be a loan that provided stable income over time, rather than an equity play. The latter requires a different set of skills and offers more unpredictable returns.

Article content

Article content

“You can come out with good recovery from a debt-for-equity swap, but if that’s showing up in strategies where it shouldn’t be, like a senior direct lending strategy, that’s concerning, and I’d worry about high frequencies of this also,” said Tamsin Coleman, head of private credit for Europe at investments firm Mercer.

Article content

Private credit firms have often touted ways they can manage borrowers that might struggle to pay their debt. Many have increased their usage of payment-in-kind, which allows companies to defer paying their interest in cash. However, debt-for-equity swaps have generally been viewed as a Hail Mary, a last resort for firms that have no option but to take a stake. 

Article content

Higher rates, stubborn inflation and sluggish economic growth in recent years has led industry players to allow borrowers to defer interest payments on loans but when the value of the equity stake is wiped out, a debt-for-equity swap can be the best option on the table. Often private lenders keep a low profile when they take part in such transactions, while their workout teams focus on improving performance, though a few come forward with explanations. 

Article content

Article content

Earlier this week, Ares Capital Corp. disclosed it made $262 million on the sale of Potomac Energy Center, a previously underperforming business that Ares lent to and subsequently took over. The fund reported a 15% internal rate of return on its investment rather than incurring a loss on the debt. 

Article content

“Our strategy is to leverage our portfolio management team to make sure,” the fund’s chief executive officer, Kort Schnabel, said on the earnings call, “we are not only avoiding losses, but capitalizing on potential opportunities to make big gains.”

Article content

Private credit funds are turning to restructuring advisers to deal with hairy situations, but smaller private credit funds in particular may have limited infrastructure to manage companies if they become owners. With these swaps, the risk of losses is still pertinent. It’s not always the case that a private credit firm will be able to turn the business around and deliver a successful exit.

Article content

After Tikehau Capital SCA’s credit arm took over UK-based services company Momenta in September 2023, certain loss-making UK entities were placed into liquidation months later as part of the group’s restructuring, according to a person familiar with the matter.