Private credit – Feature
Private credit is the subject of much discussion in the City and beyond. This comes within the backdrop of an evolution in the financial markets where alternative investments are becoming a significant focus. This has placed private credit centre stage. Indeed, it has emerged as a zeitgeist investment, amassing nearly $1.5trn (£1.16trn) in assets globally.
One of the key attractions for more long-term focused inves- tors is that private credit looks set to be an area that may gain from the pressure on traditional banks and tighter credit conditions.
“Private market lenders have been taking market share from the banks over many years, but the pace of bank displacement has quickened since the Covid period,” says Linda Desforges, private credit portfolio manager at Border to Coast. Expanding on this point, she adds: “Private equity sponsors with companies that are focused on growth see the advantage of borrowing from private credit providers who can offer a tai- lored solution to the borrower, close transactions with speed and provide additional flexibility if required.” Much of this is connected to a new, more uncertain economic and political environment, where banks and regulators are more cautious. This can be seen by the tightening of stand- ards in the US as highlighted in a first quarter survey of senior loan officers.
A narrowing market
Desforges places these developments in context. “The 2023 banking crisis, with the demise of SVB, Signature, Credit Sui- sse and First Republic Bank, added further pressures, at least on a temporary basis.
“This led to a narrower banking system, where banks prioritise healthy capitalisation ratios rather than creating new loans,” she says, adding that tighter credit conditions are “supporting the attractive pricing environment currently available in pri- vate credit”. Stéphan Caron, head of EMEA private debt at Blackrock, broadly concurs with this picture. “Traditional banks will con- tinue to play a vital role in the financing of economies, but pri- vate debt funds will continue to gain a higher share of the funding pie,” he says.
This is all within the wider perspective of the private credit market being robust. A perspective highlighted by Lushan Sun, private credit research manager at LGIM Real Assets. “The private credit market has generally been resilient this year,” she says. “The investment grade and crossover space has seen decent deal flow, pricing discipline, strong premium and, not forgetting, a higher yield environment.” Here, when discussing the banks, she says that it is important to “note that tighter credit conditions and bank retrenchment is likely to accelerate the shift towards private market financing”.
Jo Waldron, head of client and solutions, private credit at M&G, reinforces the view that the banking situation will benefit the asset class. “Private credit looks set to benefit as banks continue to retrench from credit markets,” she says.
“This continues the trend seen post the global financial crisis, with banks’ willingness to lend being further curtailed by the macro-economic downturn and cautionary demise of Credit Suisse alongside a handful of smaller US banks.” For private credit this creates a wider opportunity set to step in with customised funding streams “for borrowers with lender interests at heart”, she adds.
Different regions also offer different opportunity outlooks. In the US, there have been some interesting developments. Caron points to the widely anticipated contraction in bank lending, which could provide two tailwinds for private credit, especially direct lending. “For one, an expansion of the addressable market of potential borrowers, including in the upper middle market. Then there is enhanced pricing power versus the public markets, reflec- tive of the certainty of execution that private credit provides,” he says. In Europe, Caron continues to see wider adoption of private debt, in particular across Germany, the Benelux and the Nordics.
A step back in time But there is another perspective. As private markets are com- plex, with some often having high levels of risk and volatility, they are therefore not suitable for all investors. Nevertheless, how should investors approach private credit given this aspect to it?
The answer for Caron is simple. “Investors have in recent years turned to asset classes such as private credit for income in a low-rate environment,” he says. And he shifts the risk debate to the appeal of the asset class. “Even as many central banks raise interest rates, the appeal of these assets persists,” Caron says. He expands on this point by adding: “While higher rates bode well for yields in public markets, they also portend even poten- tially more attractive returns for private debt holders across the spectrum of financing options, as many deals have floating- rate structures that lead to higher yields as rates rise.” One of the key drivers for the increased allocations to private credit is the low volatility versus public markets in addition to the attractive returns. Caron believes that he may have seen something like this before. “The weak performance and market
structure
challenges in liquid fixed income with mark-to-mark dynamics is accelerating the barbelling approach toward passive and pri- vate assets – in the same way we saw in equities 10 years ago –
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