December 20, 2023 (Preqin News) – Private debt proved a draw for investors in 2023 as inflation concerns and economic uncertainty prevailed throughout the year.
Private debt fundraising outperformed most other private capital strategies, with the relatively high returns, floating rate structures, and senior position in the capital hierarchy attracting those concerned about higher risk, equity-based alternatives.
Fundraising for the year to date is approaching 2022’s total of $218.5bn, with $193.4bn raised from 188 fund closes, according to data from Preqin.
‘2023 was a year where private debt was under the spotlight, and the asset class’s results were broadly positive,’ RJ Joshua, Vice President, Head of Private Equity, Research Insights, at Preqin said in this year’s Preqin Global Report: Private Debt. ‘Fundraising held up in difficult conditions, as LPs remained supportive of the asset class.’
As 2023 nears its close, and with expectations of a higher-for-longer interest rate environment consolidating and the economic outlook remaining cloudy, Preqin News spoke with GPs to gather their views on the prospects for fundraising, deals, and performance in 2024.
On fundraising...
‘We expect global investor demand to remain robust in 2024. Demand continues to be high for the yielding areas of private debt, alongside conservative, scaled, and partnership-driven managers. The opportunity to receive 12% yields for senior secured loans to performing middle-market companies is extremely attractive.
‘Similarly, our junior capital rates of return are up to 15%, with lower-leverage multiples, covenants, and blue-chip sponsors contributing significant equity.’
Randy Schwimmer, Co-Head of Senior Lending, Churchill Asset Management
‘The asset class continues to be very popular. In years such as this, where returns have continued to go up, people are seeing that direct lending is well-positioned in terms of downside protection, with very limited mark-to-market risk. However, we’re also seeing greater recognition of the fact that manager activity varies across different segments of the direct lending market.
‘As a result, we’ve seen more investors in the space – particularly larger ones – seek to create some form of diversification within their direct lending allocations.’
Trevor Clark, Founder and Managing Partner, TPG Twin Brook Capital Partners
‘The outlook for 2024 is positive. Based on numerous LP surveys and a pickup in activity from Q3 2023, we expect private credit to continue to grow. We expect a rise in demand for multi-strategy evergreen solutions and further diversification, with investors allocating to strategies such as NAV financing and risk sharing to complement more traditional strategies such as direct lending.
‘The growth of newer strategies is part of the natural evolution of the asset class but is also driven by fundamental factors such as high interest rates and, in the case of the rise in demand for risk sharing, regulation.’
Harriet Steel, Partner and Global Head of Clients, Pemberton
‘The fundraising prospects for private credit remain strong, with one notable pocket of demand being in asset-based specialty finance. Institutional investors and wealth managers have built allocations to private credit over the last several years and they are now thinking about how to further diversify and insulate their portfolio from volatility, while still delivering high cash yield and total return.’
David Ross, Managing Director and Head of Private Credit, Northleaf Capital Partners
‘We believe that the prospects for fundraising will remain strong in 2024. Within private debt, strategies away from traditional sponsor-backed lending will be the most attractive, namely unsponsored middle-market lending, where investors enjoy more industry diversification, a lower degree of lender competition, and the benefit of a sponsorship and value-add approach, which can result in a better risk-adjusted return.’
Jason Beckman, Co-Founder and Managing Partner, Colbeck Capital Management
On deals...
‘We ran below our peak levels of deployment in the first half of 2023, mainly driven by a lack of M&A volume and borrower credit quality, but saw a big uptick in Q3, and Q4 volume is going to be quite high.
‘The uncertainty in the market hit investor confidence, which you need for a functioning M&A market. But that is working its way through the system and companies and investors have more confidence in growing revenue and cash flow going forward.
‘We’ve also seen an increase in the quality of deals, with a large number of deals making it through to our investment committee in the last two months of 2023. As a result, we have very strong momentum going into Q1 2024.’
Eric Capp, Partner, Head of Origination and Co-Head of Direct Lending, Pemberton
‘We expect deal flow to pick up in 2024 as uncertainty around the interest rate environment starts to subside, particularly in industries with less-cyclical demand drivers and recurring revenue models, including financial services, insurance brokerage, industrial, and non-discretionary home services.’
David Ross, Northleaf Capital Partners
‘As commercial and regional banks, which have historically provided the vast majority of financing to non-sponsored companies in the middle market, continue to pull back their lending activities, we expect to see a material increase in non-sponsored deals among non-bank lenders.
‘There is a massive opportunity for non-bank lenders to gain meaningful market share in the non-sponsored market in 2024 and beyond.’
Aaron Kless, Managing Partner and CIO, Andalusian Credit Partners
‘Until recently, the private credit market was relentlessly borrower-friendly, but power has shifted back toward investors. Lower leverage, higher yields, and the resulting risk profile mean 2023–2024 vintages are likely to be very strong in both credit quality and return profile.
‘On a 12–24-month view, loan origination is likely to regain momentum amid a wave of maturing loans from 2025 onward and private equity dry powder. These drivers are likely to ignite the origination pipeline.’
Murtaza Merchant, Managing Partner, MV Credit
‘We expect a strong year for capital deployment. Non-sponsored transactions experienced robust activity levels in 2023 compared with the sponsor-backed market, which suffered from a precipitous decline in M&A volumes. We expect to see transactions in both segments of the market in 2024, with a continued heavier weighting toward non-sponsored deals.’
Kevin Griffin, CEO and CIO, MGG Investment Group
‘With regard to M&A activity, our expectation is that 2024 is going to be more active than 2023, but we don't believe it will reach the levels of 2021 and 2022. Question marks remain around the economy and interest rates. We expect to see additional flow in the lower middle market from private equity-backed companies.
‘In general, hold times have extended and people have held on to assets longer than they traditionally would have. That has to stop at some point, and we think some of that volume will come to the market when it does.’
Trevor Clark, TPG Twin Brook Capital Partners
On performance...
‘While the US economy has proven very resilient, higher-for-longer interest rates are shrinking interest and fixed charge coverage ratios for borrowers, increasing the risk of default. But managers have more lead time to prepare for an actual default, leading to better outcomes and recoveries.
‘If 2024 brings the softest of landings, as is now widely anticipated, we expect direct lending defaults to remain at modestly low levels, below those of broadly syndicated loans and high-yield bonds.’
Randy Schwimmer, Churchill Asset Management
‘I am very concerned about certain loans made to unproven businesses during the “free money” era of the past decade, many of which were structured with poor downside protection.
‘Some might believe that inflationary pressures and the overall new cost of capital have not hurt the economy – and are counting on rates returning to below 2% in the next 12-to-24 months. I do not share that optimism and believe that the defaults seen in the coming years will be drastically different from historical precedents.’
Kevin Griffin, MGG Investment Group
‘While we remain confident in our underwriting and covenant structuring, we are also seeing interest rates push other borrowers into stressed situations, providing us with new opportunities to invest as a platform investor or creating an M&A opportunity for our borrowers. A higher-rate environment makes private debt an attractive asset class while also creating a larger opportunity set.’
Jason Colodne, Co-Founder and Managing Partner, Colbeck Capital
‘When you look at the interest rate margins, add fees, the positive impact of capex facilities, and acquisition facilities, investors are receiving a significant premium in direct lending returns today compared to historical averages.
‘Volatility is also very low compared with traditional fixed income, which is particularly important for insurance companies and pension funds. I wouldn’t want to minimize the risk of defaults and distress – and companies have to manage their costs, investments, and growth very carefully – but so far portfolios have held up quite well in a challenging economic environment.’
Eric Capp, Pemberton
‘We’ve continued to see strong returns across the U.S. direct lending space. Default rates are still relatively low, despite the higher cost of financing. Going forward, however, we believe we’re going to see a divergence between first lien senior secured – where there is no commercial bank in front – and some of the riskier parts of the capital structure.
‘Also, where there is less interest coverage, cracks are starting to form around borrowers’ abilities to meet the ongoing cost of financing.’
Trevor Clark, TPG Twin Brook Capital Partners
The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.