By Kelsey Butler
Private equity is booming, thanks in large measure to private credit, a rapidly growing slice of the debt markets where ever-growing pools of capital supplied by large investors are mobilized outside of traditional lending channels. Private credit has supplied the leverage that’s helped private equity buy the businesses that have expanded its collective portfolio to its current $4 trillion. Also known as private debt, non-bank lending, alternative lending or shadow lending, private credit’s growth mirrors the retreat by banks from lending to smaller or riskier borrowers after the financial crisis. Regulators and industry watchdogs have flagged concerns about the risks that lurk within this often-opaque market.
1. How big is private credit?
Globally, private credit, which includes distressed debt and venture financing, has ballooned from $42.4 billion in 2000 to $776.9 billion in 2018. By one estimate, the total is likely to top $1 trillion in 2020. More than half of the institutional investors in private debt are in North America (56% at the end of 2018), but the field is growing quickly in Europe (25%) and Asia (13%).
2. Who’s making those loans?
Public pension funds, insurance companies and family offices are some of the biggest investors putting money to work in private credit. Private equity firms themselves have also flooded into the space, forming their own credit arms or raising cash for private credit vehicles, along with private equity funds of funds from these investors. The frenzy has turned some lending start ups into heavyweights almost overnight. Owl Rock Capital Partners — a New York firm founded by Blackstone, KKR and Goldman Sachs veterans — has amassed $13.4 billion of assets since it started in 2016.
3. Who’s borrowing?
Historically, private credit transactions tended to focus on small- or mid-size companies. But shadow lenders have been doling out bigger checks lately, including a $1.25 billion loan to finance Ion Investment Group’s acquisition of financial data provider Acuris just this year. That’s in keeping with the trend in which private credit is more involved with lending to private equity firms. Sometimes the loans are made directly, and sometimes indirectly, through loans to so-called sponsor-backed companies -- firms that private equity shops have purchased or are in the process of purchasing.
4. What’s the appeal?
For the lenders, it boils down to one word: yield. A decade of central bank stimulus caused yield to evaporate in the usual places, such as the debt of blue-chip corporations. Loans in the private credit market are usually more lucrative than those to bigger or safer companies, with all-in yields of 7% to 9%, sometimes much more. That compares to about 3% for the typical investment-grade corporate bond.
5. How does it work?
Private credit is an umbrella term for a number of different financing structures. Here’s a breakdown, with their assets under management as of December, as reported by Preqin, a London-based research firm that tracks the asset class:
- Direct lending: Companies borrow directly from an alternative lender acting alone or as part of a small group of lenders (in what’s called a club). They typically hold the loan to maturity.
- Assets under management as of December: $266.4 billion
- Distressed debt: Investors snap up debt of companies that are trading at a significant discount, hoping to turn a profit or end up owning assets as the company restructures or liquidates.
- Assets under management as of December: $207.9 billion
- Venture debt: Debt financing products offered to startups that have yet to bring in earnings.
- Assets under management as of December: $13.8 billion
6. What’s in it for borrowers?
Better terms. Big banks are less likely to give bespoke financing than, say, a direct lending “club” that’s been formed for the express purpose of making a particular loan to a particular business. Borrowers often also have an easier time getting financing from private debt shops than in other parts of the credit market. Regulators worry that as private equity and the alternative lenders who finance it become more intertwined, looser loan covenants could be setting the lenders up for trouble later.
7. Are there other risks?
An influx of new lenders and fresh cash in the space has contributed to cutthroat competition and looser covenants -- terms lenders impose on borrowers to help protect their investments -- in addition to thinner returns. Regulators in Europe have taken note of private credit’s boom, saying its growth has been accompanied by signs of increased risk-taking. UBS credit strategists have called private credit “ground zero” for concerns due to the increased leverage on direct loans. Covenants can also be undermined when borrowers goose their earnings by, for instance, claiming savings from ambitious cost-cutting programs that may never come to pass. Jamie Dimon, CEO of JPMorgan, has also said some non-bank lenders may not survive an economic slump because they’re holding lower-quality loans -- and their disappearance could leave some borrowers “stranded.”
The Reference Shelf
- QuickTake explainers on direct lending, business development companies and shadow banking.
- McKinsey & Company’s global private markets report.
- A whitepaper from Preqin about the worldwide private debt market.
- Deloitte’s direct lending fund raising tracker.
- A Bloomberg feature on investors piling into private credit.
— With assistance by Marianna Duarte De Aragao, and Rachel McGovern