José A. Alvarado Jr. for WSJ
Individual investors accelerated their withdrawal requests from once-hot private-credit funds in the second quarter, adding to the squeeze the industry is facing as fundraising slows and money heads for the exit. So far, investors in four large credit funds, including those managed by Blackstone and BlackRock, have requested to redeem about $12 billion in the second quarter, up from $7.7 billion the previous quarter…….Continue reading…
By : Matt Wirz
Source: WSJ
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Credits:
Private credit has long existed (as long as businesspersons have been lending money to one another) but has not always been as voluminous as it is today. The private credit market has shifted away from banks in recent decades. In 1994, U.S. bank underwriting covered over 70 percent of middle market loans.
By 2020, U.S. banks issued/held around 10 percent of middle market loans. The direct lending market expanded rapidly after the 2008 financial crisis, when the SEC tightened restrictions and capital requirements on public banks. As banks decreased their lending activity, nonbank lenders took their place to address the continued demand for debt financing from corporate borrowers.
Private credit has been one of the fastest-growing asset classes. By 2017, private debt fundraising exceeded $100B. In 2024, private debt funds provided 77% of leveraged buyout debt financing globally, representing the highest share since 2015. Banks provided the remaining 23%, notably representing the lowest share for banks over the same period.
One factor for the rapid growth has been investor demand. As of 2018, returns were averaging 8.1% IRR across all private credit strategies with some strategies yielding as high as 14% IRR. Returns since 2000 are higher than those of the S&P 500 index. At the same time, supply increased as companies turned to non-bank lenders after the 2008 financial crisis due to stricter lending requirements. Private credit investment rose in emerging and developing markets by 89% to US$10.8 billion in 2022.
One recent trend has been the rise of covenant-lite loans (which is also an issue for publicly traded investment grade and high yield debt). This has been driven by investor demand for the relatively high yield compared to alternatives and a willingness to accept less protections. This has resulted in fewer company restrictions and fewer investors’ rights if the company struggles.
That being said, for the investment firms, covenant-lite loans can also be helpful because of the negative optics if a portfolio company goes into default, and fewer restrictions means fewer ways a company can go into default.[16]In addition to private funds, much of the capital for private debt comes from business development companies (BDCs).
BDCs were created by Congress in 1980 as closed-end funds regulated under the Investment Company Act of 1940 to provide small and growing companies access to capital and to enable private equity funds to access public capital markets. Under the legislation, a BDC must invest at least 70% of its assets in nonpublic US companies with market value less than $250M. Moreover, like REITs, as long as 90% or more of the BDC’s income was distributed to investors, the BDC would not be taxed at the corporate level.
While BDCs are allowed to invest anywhere in the capital structure, the vast majority of the investment has been debt because BDCs typically lever their equity with debt (up to 2X their equity), and fixed income investing supports their debt obligations. With regards to size of the market, as of June 2021, BDC assets totaled $156 billion from 79 funds.
Direct lending is a form of corporate debt provision in which lenders other than banks make loans to companies without intermediaries such as an investment bank, a broker or a private equity firm. In direct lending, the borrowers are usually smaller or mid-sized companies, also called mid-market or small and medium enterprises, rather than large, publicly listed companies.
Lenders are generally asset management or private debt fund manager firms. Direct lending funds use leverage, but generally less than banks or collateralized debt obligation funds (CDO/CLO). Private Debt primarily focuses on investing at the top of the capital structure, primarily in senior, secured first lien debt. Investing at or near the top of the capital structure reduces risk relative to equity. Direct Lending includes Senior Debt and Unitranche Debt.
Quarterly interest payments drives a constant cash flow stream throughout the deal life. Because the total AUM of both Private Equity and Private Credit exhibited strong growth from 2013-2023, the proportion of Private Credit has remained relatively steady for the past decade. The assets under management (AUM) in Private Credit has grown by almost 4 times over the past decade.
Private Credit metrics are proxied by Direct Lending which has exhibited strong performance through economic cycles. CalPERS references a Direct Lending benchmark as represented by the Cliffwater Direct Lending Index having market size of $263 billion as of December 2022.
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