Private credit is on pace for another big year as capital commitments mount
Private credit is on pace for another big year as capital commitments mount
Last year’s gold rush to private credit has continued into this year, as investors, managers, and companies in need of debt capital have found common ground. The story of how we got here is old news: traditional banks are far more conservative with their loan portfolios post-Global Financial Crisis (GFC), opening a door for private lenders. Since the end of 2009, private credit assets under management (AUM) have grown from $264bn to almost $1tn as of last September, according to Preqin Pro.
Among private credit funds focused on North America, funds of vintage 2020 – a year when the COVID-19 pandemic overshadowed the globe – closed $148bn in capital (Fig. 1). Through the first five months of 2021, funds of this year’s vintage have closed only $26bn; however, another $64bn of targeted capital is being raised. The sum, $90bn, is already higher than 2016 or any year prior, and on pace to top the average $103bn secured by fund vintages 2017-2019.
How did we get here? Low interest rates and high yield spreads are a good place to start. The Fed’s lower-for-longer policies are a well-storied culprit, but positive economic data and equity markets that are performing well signal a less risky investing environment. And underlying it all is that investors need to obtain yield from less volatile debt securities at a time when high-yield/low-risk options are rare. While this has been the case for the better part of the last decade, the surge in private credit assets suggests many are willing to trade liquidity for returns, even if it means stepping further out on the risk spectrum than they would normally.
Aggregate capital figures reveal a shift in focus from 2020’s bargain hunting to more forward-looking direct lending funds in 2021. Distressed lending funds raised a total $35bn last year across 19 vehicles, well ahead of the next-largest asset gatherer, senior direct lending ($24bn). The emphasis on distressed debt was clear as the COVID-19 pandemic stressed nearly every aspect of North American and global economies, leaving many otherwise healthy businesses in need of liquidity. How these funds perform is yet to be seen as government stimulus provided cheap, and in many cases, forgivable loans to help businesses stay afloat.
The 2021 vintage, however, is showing signs of a return to normalcy. This time, private credit lenders have put far more money into direct lending strategies. Broad direct lending funds have raised or are targeting $23bn so far this year, followed by $21bn for senior debt direct lending. Distressed debt funds trailed with $13bn in capital.
As a clearer picture of the economic growth ahead comes into view, future prospects are positive. That said, many industry players are still cautious of making more risky bets.
In the end, it may be the borrowers who win out – or at least win the most. The industry is headed for uncharted territory with regard to the amount of capital in the market. As more capital floods the space, competition among managers and pressure from investors to put money to work will tighten spreads and result in covenant-lite loans. The impact on returns for these newest vintages will need to play out over the next few years; however, median IRR data for fund vintages 2013-2017 demonstrates that the industry can handle a greater influx in capital (Fig. 2).
This is certainly not a foreboding outlook for private credit, but rather a sign that the industry is maturing. Like private equity, returns will dip as more participants enter the market, but private debt will still be seen as a higher-yielding alternative to its public market counterpart. Liquid or not, public credit is no longer the rock it once was and, like equity, private markets are calling.