Private Credit’s “Reformation Age”: The Rising Importance of Restructuring Expertise in Private Credit Firms

As the private credit market braces for a wave of debt maturities, private credit firms are finding their skills and strategies stretched beyond mere financial structuring. The evolving landscape demands a hands-on approach to managing distressed investments, including skills in debt workouts and restructurings and business turnarounds. This shift underscores a crucial transition in the private credit sector, highlighting the need for firms to adapt and expand their capabilities to ensure resilience and continued success.

The past years, characterized by historically low-interest rates, have indeed fostered a conducive environment for aggressive capital structuring and borrowing. Companies have been able to leverage cheap debt to fuel growth, acquisitions, and operational expansions, often underpinning their financial models on the assumption of perpetually low borrowing costs. This environment has also been ripe for private credit firms, which have stepped in to fill the void left by traditional banks, offering bespoke financing solutions to those entities often deemed too risky or overlooked by conventional lenders.

However, as central banks globally tighten monetary policy to combat inflation, the resultant higher interest rate environment is starting to exert pressure on those very capital structures that thrived under the assumption of low costs of capital. And, as a significant amount of low-cost debt approaches maturity, the ability of borrowers to refinance at higher rates becomes more difficult. For private credit firms, the ability to manage distressed assets effectively has become paramount.

“I call this era of private credit the Reformation Age,” says Arif Bhalwani, CEO of the Toronto-based private credit firm Third Eye Capital. “Just as the Reformation called for an active engagement with one’s faith and a personal responsibility towards salvation, the modern private credit landscape demands a hands-on approach to managing distressed investments. Lenders must possess the skills not only to evaluate and mitigate risks preemptively but also to intervene directly and effectively when investments falter. This includes the ability to take over and run distressed businesses, much like reformers sought to actively shape and guide religious practice according to new principles.” Most private credit firms have yet to experience a significant stress event to test their acumen. But as bankruptcies and restructurings spike, the adaptability of private credit firms will be put to the test. 

“Making loans is easy – it’s getting repaid that’s the hard part,” adds Arif Bhalwani. “With borrowing rates up nearly three-fold since the lows of the pandemic, an increase in the number of companies struggling to meet their debt obligations is inevitable.”

The impending load of maturing debts represents a potential inflection point for the private credit industry. This scenario places private credit firms at the forefront of a complex situation, requiring them to engage in the restructuring and turnaround of businesses facing operational challenges.

Restructuring involves renegotiating the terms of a loan or advancing new terms to allow a financially distressed borrower to regain stability and improve liquidity. These processes require a deep understanding of the borrower’s business, including its operational challenges, competitive landscape, and potential for recovery. For private credit firms, this means going beyond the numbers to evaluate the strategic aspects of the business, identifying viable paths to sustainability, and implementing effective turnaround strategies.

Business turnaround expertise is becoming increasingly critical for private credit firms as they navigate the complexities of distressed investments. This expertise involves identifying the underlying issues contributing to a company’s financial distress, developing a comprehensive plan to address these issues, and executing the plan to stabilize and revitalize the business. Turnaround strategies may include operational improvements, cost reduction initiatives, asset divestitures, and strategic repositioning. Private credit firms that can effectively deploy these strategies are better positioned to protect and enhance the value of their investments.

“The “Reformation Age” is not a harbinger of doom but a call to evolution,” says Bhalwani. “It demands a recalibrated approach that prizes prudent underwriting, strategic foresight, and adaptability. As with any significant shift, there will be winners and losers. Those who heed the call to “find religion” in their investment and operational philosophies will likely find themselves on the right side of history.” 

To successfully manage the coming wave of debt maturities and associated challenges, private credit firms are recognizing the need to build multidisciplinary teams that combine financial analysis with operational, strategic, and restructuring expertise. This approach enables firms to take a holistic view of distressed situations, identify innovative solutions, and execute complex turnaround plans. By doing so, they not only mitigate risks but also uncover opportunities to create value in challenging circumstances.

For private credit firms willing to embrace this complexity and invest in the necessary capabilities, the future holds the promise of continued growth and success in an increasingly competitive landscape.