Navigating the Boom: The Evolution of Private Credit
GICP expert view / 20 May, 2024
In the realm of corporate borrowing, an increasingly prominent player is reshaping the landscape far from the traditional banking corridors—the private credit market. With assets under management (AUM) soaring to $1.7 trillion (as of June 2023) and projected to reach a staggering $2.8 trillion by 2028, this sector has become a beacon for investors searching for yield in a low interest rate environment and for borrowers desiring more flexible, confidential financing solutions.
The rapid expansion of the private credit market is attributed to several factors, including stringent post- global financial crisis banking regulations, heightened borrowing needs among corporates, and the attractive returns it offers compared to other credit instruments like high-yield bonds and leveraged loans. Notably, the U.S. direct lending market, a significant component of private credit, ballooned to $470.8 billion in AUM (as of mid-2023), underscoring the vigorous appetite for such investment opportunities.
Private credit stands out for its unique benefits to borrowers, including greater deal-closing certainty, quicker execution, customizable loan terms, and the opportunity for higher leverage. For lenders, it promises closer relationships with borrowers, bespoke agreements, and an illiquidity premium that compensates for the asset class's inherent non-liquidity.
| Private Credit | BSL | |
|---|---|---|
| Coupon Type | Floating rate; spread over reference rate, typically SOFR | Floating rate; spread over reference rate, typically SOFR |
| Capital Structure | Commonly senior, first lien, secured loans, though unitranche loans (a mix of senior and second lien loans) are growing in popularity | Senior secured loans, however can vary to include first- and second-lien or senior and junior debt |
| Lender | Single non-bank lender to small group of non-bank lenders; typically 1-6 lender participants, though can range to over 20 | Arranged by a large commercial or investment bank and syndicated across a group of lenders; ranging from dozens up to 200 participants |
| Rating | Borrowers typically unrated or privately rated | Borrowers usually have public credit rating |
| Pricing | More expensive than BSL due to liquidity premium | Cheaper pricing as loans can be easily traded on secondary market. Oftentimes driven by technical rather than fundamental factors due to broader investor base |
| Liquidity | Illiquid, typically held to maturity | Liquid |
| Secondary Market | Nascent secondary market for LP-led transactions for interests in fund(s) or GP-led transactions for fund assets | Well-developed secondary trading market |
| Maturity | Maturity between five to seven years though oftentimes repaid earlier at around three years | Maturity between five to seven years, also frequently repaid earlier |
| Covenants | More protective, customized covenants covering both maintenance and incurrence financial covenants | Often cov-lite, which only have incurrence covenants |
| Deal Execution | Faster execution, can be as quick as 30-75 days. Guarantee of deal execution, size and pricing as negotiated | Longer execution, typically two months Committed or best-efforts basis financing. In a committed transaction the borrower is guaranteed to obtain the agreed upon amount whereas in a best-efforts transaction the loan size and interest depends on market appetite and is not guaranteed |
| Deal Size | Deal size typically <$500 million (with some larger deals more recently) | Deal size typically ranges between $500 million-$1 billion (but can be larger) |
Table reproduced with kind permission from CreditSights, Fitch Ratings, Covenant Review
However, the sector is not without its challenges—increasing competition between private and syndicate lenders, infrequent and subjective valuations, and concerns over declining underwriting standards pose risks to its health and stability.
The structural composition of private credit funds further reveals the diversity within the sector. Funds are primarily organized as either closed-end drawdown funds or business development companies (BDCs), each catering to different investor bases with varying appetites for risk, return, and liquidity. Despite a more operating light regulatory framework, the segment has seen a year-on-year decline in cov-lite agreements, signaling a cautious stance towards covenant protections amid a competitive lending environment.
Looking ahead, the future of private credit is poised for dynamic changes. Increased regulatory scrutiny, particularly in the U.S. and Europe, seeks to address transparency and oversight concerns. Meanwhile, the anticipated emergence of a secondary market could revolutionize liquidity, offering new trading opportunities and potentially broadening the investor base. Additionally, the market is witnessing a trend towards consolidation, with larger funds capturing a significant share of capital.
This article is a brief overview of the three-part report ‘Private Credit Primer’, from CreditSights. You can request the full report here .