The Growth of Private Credit Market

The growth of Private Credit Market in recent years!

In this article, I will talk about what Private Credit is, astronomical market growth, types of private credit, why firms opt for Private Credit lenders, why investors prefer to allocate part of their managed funds to private credit players, and potential risks of private credit.

Private credit refers to loans or debt investments made by non-institutional lenders, principally, private companies (e.g. Capital/Investment firms) that provide capital through private markets. It differs from traditional lending in terms of yields (higher yields) and less restrictive terms offered to companies that lack access to debt from commercial banks. The private credit (PC) market has been growing exponentially in recent years, expected to reach $3 trillion market by 2028, according to Moody’s.  It stood only at $1 trillion in 2020 (2x growth). One primary growth driver of this boom is that after the 2008 financial crisis, regulations on banks were tightened, limiting their ability to lend to certain sectors, particularly middle-market companies. As a result, businesses are turning to private credit markets to fill the lending gap. Furthermore, since interest rates remain relatively low in many parts of the world for an extended period, investors have sought higher yields than what is typically available in traditional bond markets. Private credit offers higher yields which attract institutional investors like pension funds, insurance companies, and family offices. Also, unlike traditional bank loans, private credit can provide companies with faster access to capital, making it an attractive alternative for businesses that need funding quickly.

Private credit market offers various types of lending:

- Direct lending: where private-capital-credit providers lend directly to mostly middle-market firms

- Distressed debt (also known as high-yield): when firms intend to rescue drowning companies by providing money, seeking very high returns to offset the risks being taken

- Mezzanine debt: some middle-market companies seek to grow and/or make acquisitions, thus; Mezz debt offers a hybrid form of debt, which is between senior debt and equity. Some Mezz debt would have conversion features (convertible debt)  

- Structured finance: these complicated financial instruments are mostly backed by assets such as mortgage-backed securities, asset-backed securities, etc

In the chart below, it’s illustrated that most loan issuances were “direct lending”. This chart also displays the growth of the private credit market as mid-sized companies access capital through private credit providers as opposed to traditional banks like JPMorgan, Citi Bank, Bank of America, etc.

 Companies turn to private credit for several key reasons. First, it offers flexibility with customized repayment schedules and covenants tailored to their needs. Additionally, private credit provides faster access to capital compared to traditional bank loans, which can be a significant advantage when time is of the essence. Many businesses also seek private credit as an alternative to bank financing, especially when banks are unwilling to lend due to regulatory pressures or a preference for avoiding more complex loan processes.

Private credit carries several risks that, one of which is illiquidity.  These investments often have longer holding-period, making it more difficult to sell them quickly if necessary. Credit risk is another concern, as if a borrower defaults, the lender may struggle to recover their investment, particularly with unsecured or subordinated loans. Broadly speaking, private credit markets also are influenced by economic cycles, during an economic downturn could increase the likelihood of borrowers struggling to repay their loans.

Ahmed Almuhr