A Decade on, Private Credit Matures and Evolves

Investors and sponsors gathered in New York City for the SuperReturn North America conference last month, with a focus square on private credit. It’s no secret that over the past decade, private credit has emerged as the bedrock of middle-market financing, and last month’s conference took stock of the past decade in private credit, evaluating how the industry has matured and where it might go as deal sizes and balance sheets grow.

Nearly all panels recognized that despite the slowdown in M&A, 2023 and likely 2024 will represent “goldilocks” vintages for private credit. Higher interest rates mean returns for direct lending investments made during this time will also increase, and because leverage levels are lower, borrowers are putting more equity into deals. As a result, loan-to-value ratios have improved, creating a lower risk profile for private credit funds, panelists said.

These positive conditions are also supported by strong fundraising. According to data from PitchBook, private credit is on pace to reach $200 billion in new capital raised for the fourth year in a row.

If these trends play out as expected, the goldilocks years could bolster aggregate private credit performance. Industry analysts and investors had started to raise questions about the durability of private credit returns given the slowdown in M&A. But panelists were quick to point out that deals were still getting done—now, with stronger terms. The test for 2024, they said, would be whether or not defaults increase to the extent that any gains from the stronger conditions happening now are outweighed by growing issues with legacy loans that are now significantly more expensive.

The conference also highlighted how private credit continues to evolve. With billions in freshly raised capital waiting to be deployed, private credit is expanding its presence in more than just direct lending and has started to build a secondaries market to give investors and GPs more options.

Asset-Backed, Non-Sponsor, and Specialty Finance

Sluggish debt markets are hitting more than just private equity deals. Companies are also looking for ways to finance expansion plans and other growth initiatives—and coming up short. Several of the conference’s panels focused on private credit’s growth in areas including asset-backed finance, non-sponsor financing and specialty finance. Private credit funds have offered services in all three areas for several years, but panelists pointed out that recent regional bank failures have caused banks to retreat further from these areas giving private credit the opportunity to grab market share.

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Data from KKR shows significant growth in private asset-backed finance. By the end of 2022, the market was 67% larger than it had been in 2006 and 15% larger than it was in 2022. KKR’s analysts expect that the market will grow to $7.7 trillion in aggregate by 2027.

“It’s really difficult to access capital markets across the board right now,” said panelist Patrick Dennis, co-deputy executive managing member at Davidson Kempner Capital Management LP. “Even publicly traded firms are focused on where they can find financing.” That trend presents an opportunity for private credit funds to provide support, but Dennis was quick to add that it’s important to stress test business models before underwriting: “We can’t underwrite to the 2021 or 2022 growth projections. We have to step back and develop our own opinions about each industry and how we expect it to perform.”

It’s really difficult to access capital markets across the board right now. Even publicly traded firms are focused on where they can find financing.

Patrick Dennis

Davidson Kempner Capital Management LP

That basic view was echoed on the panel Sponsors vs. Non-Sponsored: Comparing Performance in a Dislocated Market. Private credit funds have traditionally focused on sponsored finance, but panelists noted that there is an opportunity to generate alpha by expanding into non-sponsored finance as a new area of deal origination.

“Part of our alpha is in non-sponsored origination,” said Pete Fisher, managing director of Vista Credit Partners, the private credit affiliate of Vista Equity Partners, during the panel. By funding companies on their own and not having to engage in a competitive process, it’s possible to customize terms, he said. Data presented during the panel shows that often private credit managers can get margins 150-200 basis points higher in non-sponsor finance deals, typically with lower total leverage extended.

“We’re around the table working with a number of shareholders thinking through structuring and getting any consensus we might need,” Fisher said. “That’s different from working with a single controlling shareholder who is making that decision unilaterally based on their priorities.”

Investors are also supportive of this expansion. Allocators on each of these panels noted their interest in diversification within private credit to help limit risk. “We are looking at the different return profiles within credit and there are a lot of interesting opportunities right now,” said Matthew Stoeckle, director of Capital Solutions at Liberty Mutual Investments. “We’re focused on risk and what kind of risk we’re taking relative to the opportunity set. There is a lot more you can do now to hit your return target.”

A Maturing Industry

Private credit’s expansion into a wider variety of financing wasn’t the only big trend on display. The advent of private credit secondaries was also a hot topic. The private credit secondaries market is rapidly growing: it reached $17 billion worth of activity in 2022, a figure more than thirty times the volume of deals done in 2012, according to data from Collier Capital and PitchBook.

Related content: Private Credit’s Rise Continues—But Not Because of SVB

By all accounts, investors and GPs are approaching the secondaries market for private debt in much the same way as they do for private equity—selling stakes, restructuring portfolios and generating liquidity as needed. This is still a new area within the private credit landscape but one that suggests that the industry is maturing rapidly.

Speaking on a panel devoted to private credit secondaries, Mike Hacker, global head of portfolio finance at AlpInvest, called it the “Bronze Age” for private credit secondaries. “We still have sort of rudimentary tools—we’re not yet where we were ten years ago in private equity secondaries—in terms of contracts and standardization. There are still misalignments. So you have to pick and choose,” he said, adding that while it’s still early days the demand for a robust secondaries market suggests that the industry will adapt quickly.

Bailey McCann is a business writer and author based in New York.

Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.