Five Key Trends in the Current Private Credit Market

What are the latest trends shaping the US $1.5 trillion private credit market? With many factors impacting the current market, from the end of easy money and the aftershocks of recent bank failures to new product offerings and beyond, five key trends have emerged.

1. The industry is growing:

The private credit industry now is an approximately US$1.5 trillion market, consisting of direct lending, mezzanine funds, real estate and more. The market is growing by an average of 10+ percent per year, mainly driven by two categories of investor:

• Institutional investors who are looking for higher-yield investments to help rebalance their portfolio as bond markets have gotten less attractive.
• High net worth individuals who are willing to give up some of their liquidity – committing to longer terms than they may be used to in public equity markets – in exchange for access to better returns.

2. Growth brings new types of products, but complexity means costs:

Growth brings change, and as interest in the asset class grows, managers are offering new bells and whistles to draw investor attention. These can include changes in terms – such as easier access to liquidity – as well as more targeted offerings, such as funds focused on a particular geography or industry.

These new options can offer investors more clarity, but they come at a cost for managers, including the time, attention and staff required to underwrite and manage more focused portfolios. They also bring opportunity cost as managers are constrained by a particular fund’s focus. For example, a fund focused on software companies may feel compelled to underwrite loans and put investor money to work even if managers see more promising opportunities elsewhere.

As complexity and specialization come to the fore, the panelists also caution that there will always be a role for generalists. Training and staffing industry specialists is an attempt to time the market, and if market forces shift investor focus from software companies to something new (for example), it’s important that managers have experienced, flexible generalists who can get up to speed in a new sector quickly.

3. It's not just investors who are driving growth in private lending – it’s also the customers:

The big question after the 2008 financial crisis was ‘when would big bank lending be back?’ and over time the answer has become ‘it won’t.’ At the same time, interest rate risk and the much-publicized crises of a few regional and mid-size banks have triggered a new phase of de-risking.

These trends are converging – larger companies who used to rely on banks for financing now find themselves turning to private lenders, just as private lenders have now amassed the assets under management, the investor confidence and the underwriting sophistication to handle larger deals.

4. The recession is already here, unless it isn’t, but maybe it doesn’t matter:

Perspectives vary on whether a recession is coming or it has already arrived, but for private credit that debate may well be moot – for lenders and borrowers, the big seismic event for the economy has already happened, and that was the end of zero percent interest. The end of the free money era has already changed the fundamentals of borrowing and lending in so many ways that a few quarters of recession will likely seem relatively minor, when and if it comes.

5. Deals are down, but not forever:

The aftershocks of interest rate rise are tamping down enthusiasm for deals, as sellers (who want yesterday’s prices) and buyers (who are worried about tomorrow’s rates) struggle to align on a shared definition of what ‘fair’ means. Still, beyond the short term, most aren’t expecting things to pick back up, thanks to the bigger picture fundamentals that are still in place: huge amounts of investor dry powder, the decline of bank lending and the need for customers to access capital.

While the long-term prospects for private credit remain positive and make the asset class an attractive one, most aren’t expecting a significant wave of M&A activity. Merging with another fund effectively entails re-underwriting its entire portfolio – it’s much easier to grow organically by raising additional funds and taking on larger customers.

This article is based on insights shared during a panel discussion at the 2023 Permanent & Private Capital Summit. Speakers on the Views on the Current Market: What a Year it’s Been panel included Richard Byrne, President, Benefit Street Partners, David Golub, President, Golub Capital, Craig Packer, Co-President and Senior Managing Director, Blue Owl and Daniel Pietrzak, Partner and Global Head of Private Credit, KKR. The panel was moderated by Dechert Partners Omoz Osayimwese and John Timperio.