Credit Crunch: Proskauer’s Boyko on Outcomes in Private Credit

Stephen Boyko, partner and co-founder of Proskauer’s Private Credit Group, says private-credit lenders place strong emphasis on limitations around incurring additional debt, the ability to distribute assets or cash (dividends), and on having flexible transaction documentation versus broadly syndicated loans. His comments were made on Bloomberg Intelligence’s Credit Crunch podcast and highlight legal and covenant priorities in private credit underwriting.

Analysis

Private credit’s document flexibility — especially around incremental debt and dividend/back-to-sponsor provisions — is effectively a governance arbitrage that transfers optionality from creditors to sponsors. That asymmetry increases near-term yield for lenders but raises the probability of principal impairment in stressed scenarios because cash returns to owners ahead of creditor remediation; in a mild recession (6-12 months) expect idiosyncratic defaults to cluster around sponsor-owned platforms where distributions accelerated in 2023–24.

Second-order winners are scale managers and credit platforms that standardize tighter covenants or charge explicit fees for waiver/accordion rights: they can reprice new origination spreads and generate recurring fee income even if underlying defaults tick up, creating a 12–24 month earnings kicker. Losers are retail-facing, yield-dependent vehicles (BDCs, loan ETFs) and smaller direct lenders that leaned on dividend-friendly docs — these lack the repricing power and face NAV compression and distribution cuts if marks adjust.

Key catalysts: a high‑profile default where sponsor distributions preceded loss realization would crystallize governance risk and trigger repricing across private markets within weeks; regulatory scrutiny (SEC/FSOC inquiries) would extend the window to months and force standardized covenant resets. Tail risk — regulatory clampdown or systemic liquidity shock — could force immediate markdowns across illiquid private portfolios and create fire-sale dynamics that transmit to broadly syndicated loan and CLO mezzanine spreads over 3–9 months.

Key Decisions for Investors

• Pair trade (3–12 months): Long listed private-credit managers with scale and fee mix (e.g., ARES, BX) / Short retail-yield vehicles that take direct credit risk (e.g., ARCC, PSEC). Rationale: managers capture fee repricing; BDCs are most exposed to dividend-first documents. Use 6–12 month call spreads on ARES/BX and buy 6–9 month puts (or put spreads) on ARCC/PSEC to cap premium spend. Target 2:1 upside vs premium risk if governance shock occurs.
• Event hedge (0–6 months): Buy protection against loan-market dislocation via short positions in senior loan ETF (BKLN) or by purchasing loan volatility via put-heavy structures. Size to 2–3% notional of credit book to protect against 150–300bp spread widening in syndicated loans that would flow to private-credit marks.
• Opportunistic credit (6–24 months): Accumulate first‑lien CLO/loan mezzanine selectively where underwriting is sponsor-tight but covenants are being tightened post‑deal — look for CLO equity or AAA discounts after wider spreads. Focus on deals managed by top-10 managers with loss-eating reinvestment profiles; expect IRR pickup of 400–800bps vs broadly syndicated loans but require active monitoring for covenant resets.
• Tactical options (3–9 months): Buy 3–6 month puts on select BDCs (ARCC, PSEC) as a low-cost asymmetric hedge to NAV downside if any headline regulatory action or large sponsor-led distribution misbehavior emerges. Cap position sizing to preserve optionality — these are insurance-like trades against a governance catalyst.