Welcome to the ninth edition of the Alternative Credit Council’s Financing the Economy research series, produced in partnership with SS&C Technologies. This research has become a key industry reference point, providing investors and policymakers with data and insight on the trends underpinning the growth of private credit into a globally recognised asset class.
The ninth edition comes at a time when a combination of rising interest rates, macroeconomic headwinds and political uncertainty are testing the industry in a way not seen during the past decade. In this context, it was an easy decision to focus this year’s research on the performance of private credit strategies in this environment, and examine the resilience of risk management practices in the sector.
Flexibility, speed of execution and direct relationships with borrowers remain key features of private credit. During the past year, these attributes have come to the fore for borrowers in need of finance partners they can rely on, and ones who are able to adapt to their needs. For investors, these attributes also continue to be an important driver of returns, with private credit fund managers able to address stress more proactively and effectively than other lenders. While higher interest rates are placing more scrutiny on these attributes, they also create greater potential for higher returns for lenders who can stand up to this scrutiny.
Our research also shows several larger firms continue to play a significant role in the corporate lending markets. The scale of these strategies naturally draws significant attention – and rightly so – however, the story of private credit continues to move beyond corporate lending. In line with previous predictions of this research series we also see greater interest among investors in opportunities such as real estate debt, asset backed lending, infrastructure and trade finance. It is likely that in 2024 these strategies will continue to act as additional growth engines for the asset class.
Our research also addresses questions posed by policymakers and regulators on what the growth of private credit means for the resilience of the economy and stability of the financial system. The data gathered in this paper offers a window into credit risk management practices, how firms manage liquidity and the role of leverage in private credit investment strategies. If the debate on these issues is as important as many attest, it is vital that such a debate is evidence-based. We hope that our findings will be valued by policymakers and act as an important contribution to their ongoing discussions.
We would like to thank the firms and individuals who supported this research and contributed their time and expertise. We hope that investors, private credit managers and policymakers will find our data and insights useful.
Significant growth in new lending led by larger firms
Private credit managers deployed an estimated $333bn during 2022. This was a significant increase from the estimated $200bn that was deployed globally in 2021. This growth has been spearheaded by larger lenders who deployed more than $10bn per year, accounting for 58% of total capital deployed globally. Deployment opportunities for corporate lending continue to be impacted by reduced M&A and private equity deal flow, however lenders are also more active in other markets such as large cap lending, non-sponsored debt, real estate and asset-backed lending.
Standing up to higher interest rates
Higher interest rates have shone a spotlight on fund manager risk management practices and the creditworthiness of portfolio companies. 35% of respondents identified interest rate risks as the biggest challenge affecting borrowers. The impact of interest rate rises remains localised to specific firms, fund and vintages. Where loan par value adjustments have been necessary, these are in a moderate range of 0-5% for the majority of loans. Private credit fund managers are also proactively amending loan terms where necessary, although 53% of respondents stated that such activity only applied to less than 5% of the loans in their portfolio. Initial credit selection, risk management practices and relationships with sponsors and lenders are expected to be key differentiators between firms and the returns on capital they can achieve.
Leverage plays a modest and well-managed role in private credit
36% of respondents report using no financial leverage in their private credit funds. For funds that do use financial leverage, the vast majority do so below 1.5 times of debt to equity. Subscription line financing is the most common forms of leverage used by 52% of respondents. This plays an important cashflow management role helping to smooth capital calls from investors. The main source of leverage continues to be banks who provide financing to 81% of respondents. Private credit funds and leverage providers maintain robust credit and counterparty risk management practices which are supported through detailed and frequent transparency and reporting requirements.
Liquidity risk management central to structuring
An estimated 58% of capital invested in private credit strategies is done so through closed-ended structures. 21% of capital is invested through managed accounts with 11% managed through open-ended funds, although demand for both may increase as investors explore alternative structures that can improve the efficiency of capital deployment or meet their liquidity needs. Our data also finds that private credit fund managers using open-ended structures make extensive use of liquidity management tools such as lock ups, gates, redemption windows, notice periods and slow-pay structures, with such tools tailored to the investment strategy and needs of investors.
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For more information about the report please contact Nick Smith, Managing Director, Private Credit.