• Demand growing amid market uncertainty
• Pension funds joining the action
• Local players hold an advantage

Continued uncertainty over the timing and scale of interest-rate cuts coupled with fears that Canadian banks might pull back lending amid tighter capital constraints could further increase demand for private credit from mid-market private equity (PE) firms, industry sources said.

Demand has picked up in the last 12 to 18 months amid an overall slowdown in the broadly syndicated loans market, said David Sum, managing director of the alternative income group at Ninepoint Partners that oversees four private credit funds, one of which has assets under management of more than CAD 1bn (USD 727.3m).

Mid-market private credit provider Private Debt Partners (PDP), for its part, has recently seen its deal-flow pipeline grow 15% to 20% quarter over quarter, managing partner Jeff Deacon said. The firm has developed a grassroots campaign to specifically target PE firms, he added.

PDP’s two- to five-year term loans – compared with the more traditional five to seven-year term loans – align well with the investment horizons of PE firms. “From a PE point of view, if your liquidity horizon is within five years this makes sense,” Deacon said.

About 25% of the loans made by PDP’s first, closed-end Senior Opportunities Fund (SOF) were made to PE-backed companies and the firm expects that to increase to 50% with its second fund, which it plans to close in May, Deacon said.

PE firms are attracted to the greater flexibility and shorter approval times offered by private credit, said David Ross, managing director and head of private credit at Northleaf Capital Partners.

Private credit can decrease the onus on the portfolio companies for covenants, amortization and other financing terms as well as provide increased leverage compared to traditional banks, according to a Credit Market Landscape working paper prepared by Deloitte Canada’s Capital Advisory Group.

PE-backed Saturn Oil & Gas [TSX:SOIL], for instance, turned to private credit to partake in the consolidation of Canada’s oil-and-gas sector. The Calgary, Alberta-based company used a senior secured loan facility from DFO Management, the investment office of Dell Technologies founder and CEO Michael Dell and his family, to finance four M&A deals since 2021, including its acquisition in February 2023 of privately held Ridgeback Resources for a total consideration of CAD 525.9m, as previously reported by Mergermarket.

More recently, Sagard Credit in March refinanced a Canadian bank out of a PE-backed platform that operates homecare centers for people with intellectual and developmental disabilities, said Sagard Credit partner and portfolio manager Mustafa Humayun. The bank wanted out because the platform was not growing at the expected rate, he added.

Sagard Credit is the private credit unit of Power Corporation of Canada’s [TSX:POW] alternative asset investment platform Sagard. It has deployed half of its CAD 1.4bn second opportunities fund and plans to start raising a new fund next year, he said. It also has a senior lending fund of CAD 700m to CAD 800m to provide cheaper private credit to high-quality companies and a CAD 200m retail vehicle where everyday Canadians can invest in private credit, he added.

The increase in demand for private credit has led six of the country’s biggest pension funds to expand their exposure to that asset class.

Reuters reported in January that Toronto-based CPP Investments, which manages CAD 576bn, will double its overall credit portfolio to about CAD 115bn. British Columbia Investment Management Corporation’s private debt program grew to CAD 15bn at the end of 2023 from CAD 13.5bn in March 2023, the report added.

The growing competition has led to pressures on the pricing of large private debt transactions but has had little or no effect in small or mid-sized deals, said Sum from Ninepoint Partners.

“We are specifically targeting those mid-market dealmakers that are overlooked by the major banks and large pension funds,” said Deacon from PDP. The firm’s loans are 450 to 600 basis points over Canada’s prime rate.

Competition, however, is particularly tough in Canada, where six major banks control most of the financial services industry, cautioned Humayun. “If a PE firm wants to raise debt in Canada, we’ve seen that banks will often hit the ask… because they can be keen on selling then other business over time like advisory, treasury,” he said. “I don’t see that dynamic changing.”

And yet, it is precisely during periods of stress when private credit providers can make inroads and take advantage of banks’ retrenchment like when they stopped lending to restaurants or travel companies during COVID-19, Deacon said. “When Canadian banks close the lending tap, they really close it shut,” he added.

Canadian banks might be on the cusp of pulling back from lending as parts of their balance sheets are tied up in the real estate market, which is undergoing a downturn, said Humayun, who was a former managing director at CPP Investments and a member of Goldman Sachs’ multi-strategy investing team in New York before he helped establish Sagard’s private credit unit.

Lisa Weatherbed, partner, M&A Advisory at Deloitte Canada, has been providing mid-market PE clients with private debt options, “if anything, to create a competitive tension with their current banks.”

The share of alternative lending and private debt in Canada’s total loan market has hovered around 40% since at least 2022, according to BMO citing figures from data-gathering agency Statistics Canada.