It’s likely that many middle-market dealmakers have heard the current credit market described as “better than ever”, or even mimicking a utopia. Given the overarching availability of debt financing, however, it is likely that the current environment cannot sustain itself.

The Carlyle Group (Nasdaq: CG), Antares Capital, Audax Private Equity, Madison Capital, Littlejohn, Gryphon Investors, and THL Credit are a few among the long list of lenders and private equity firms to have raised debt capital between 2016 and 2017. In today’s credit market, with basis points between 400 and 425, such broad exposure has paid off for investors. However, as the middle market approaches what dealmakers like Mark Jenkins, Carlyle’s head of credit, describe as a credit bubble, investors may begin to deploy capital less frivolously and shift toward targeted sectors.

Let’s rewind a moment. The overextension of bank balance sheets during the financial crisis of 2007 led to a credit squeeze and dramatic fall in asset prices. Back in 2006, the market reached spreads of 200 bps and many thought it was ready to implode, “but it took nearly two and a half years to happen,” according to Jenkins in a white paper detailing the current credit landscape. The Carlyle credit chief expects the credit market to cool down as central banks that support the banks’ balance sheets begin to pull back. “So, the main thing to focus on right now is that we have had over eight years of balance sheet support from the central banks,” he notes in the white paper.

During a downturn, debt capital is generally a safer investment vehicle compared with the stock market; nevertheless, investors will still want a healthy balance between equity and credit. If central banks continue to pull back their balance sheet support, traditional firms will likely do less fundraising, while investors seek to diversify their portfolio in other areas or even with sector-specific funds.

“Some of these leverage providers for private credit are getting concerned about how easy it is to raise capital,” says Mike Weinmann, managing director at healthcare-focused investment firm CRG. “These aren’t the private credit funds; these are the banks that are lending to the private credit funds.”

Another theme, per Weinmann, is that “there’s more of an appetite for specialists.” Companies are choosing firms like CRG that specialize in a sector, because they are able to “make a significant [financial] commitment without generating equity dilution.” Though Weinmann expects this abundance of credit “will stick around for a while,” he anticipates that investors will push toward the higher quality of names backing the funds in the event the credit market begins to cool down.

As with anything good that commences, low-cost debt financing will have an expiration date as well. Should the credit market begin to tighten, as these private equity professionals expect, firms should anticipate making necessary adjustments sooner rather than later.

Kamaron Leach

Kamaron Leach

Kamaron Leach joined SourceMedia in 2016, serving as Reporter of Mergers & Acquisitions. Kamaron writes the Finance Finesse column about investment banking and lending, and also covers the media and entertainment sector.