The Rise of Private Credit

The Rise of Private Credit: Transforming Corporate Debt and Governance

Over the past generation, corporate America’s debt markets have undergone a significant transformation. Historically, the trend was toward democratisation of corporate debt with widespread, dispersed ownership. However, this has reversed with the rise of private credit. Major asset managers are increasingly providing direct loans, discussed in our previous article, bypassing traditional banks. This shift, driven by tighter regulations and evolving market dynamics, has led to a consolidation of corporate debt within private investment funds. Understanding these changes and their implications is crucial for navigating the evolving credit landscape and the associated risks.

Transforming Corporate Debt Markets

Following the 2008-2009 financial crisis and stricter regulations, corporate debt markets have shifted from a bank-dominated model to one led by private credit funds. Driven by increased demand for credit and investor appetite for higher yields, private credit funds now offer high-return, high-risk loans, replacing traditional bank lending and reflecting greater flexibility and innovation in the market.

Since the 2010s, major asset managers like Apollo, Ares, Blackstone, and KKR have significantly grown their direct lending activities, with Apollo’s private credit portfolio expanding from $75 billion in 2018 to $268 billion by late 2023. The private credit market, valued at $1.5 trillion, is projected to reach $2.8 trillion by 2028. This sector is becoming more diverse and integrating with syndicated lending, with investment banks trading and rating private credit loans, reshaping corporate finance by capturing market share from banks and reaching higher-risk borrowers.

Evolution of Lending Practices

Private credit has increasingly financed large transactions traditionally managed by banks. Initially focused on middle-market borrowers, direct lending now supports major deals, with notable examples including Blackstone Credit’s $1.8 billion loan in 2021 and Vista Equity’s $4.8 billion loan in 2023. The growth in loan sizes has led to more “club deals,” where multiple private credit managers collaborate on large transactions.

Lending has evolved from traditional bank-managed loans to a market-driven model featuring syndicated loans and high-yield bonds. Over the past four decades, syndicated lending has reduced banks’ dominance by pooling resources among multiple lenders. High-yield bonds, issued by high-risk borrowers, have also expanded market access and diminished bank control. Driven by deregulation and mergers and acquisitions, innovations like collateralized loan obligations (CLOs) have increased liquidity and risk diversification, marking a shift from a bank-centred model to a more quasi-public debt market.

There is a significant growth in the number of loans outstanding in each calendar year, consistent with press reports on increasing market share of private credit asset managers in corporate loans. We observe in the graph 6,439 loans outstanding in 2014 and 20,182 in 2022.

Implications for Corporate Governance and Finance

Changes in Governance and Debt Management:

• Decreased Oversight: The move from bank-led lending to syndicated loans and high-yield bonds has reduced stringent oversight, leading to looser covenants and diminished debt discipline.
  

• Increased Leverage: The rise of private equity and direct lending has resulted in higher leverage, escalating financial risks and altering corporate behaviour.

Impact on Corporate Governance:

• Efficiency and Risk: Firms backed by private credit may adopt high-risk, high-return strategies due to fund managers’ incentives, favouring aggressive tactics.
  

• Concentration of Power: The consolidation of equity and debt within large funds centralises corporate power, raising concerns about major asset managers’ influence.
  

• Stakeholder Effects: The emphasis on investor returns can negatively impact non-investor stakeholders, potentially increasing anti-competitive behavior and reducing social welfare.

Economic and Market Implications:

• Economic Resilience: Investment concentration in a few large funds may weaken corporate resilience to economic shocks, exacerbating financial downturns.
  

• Industry Bias: Private equity and venture capital preferences can skew capital towards favoured industries, like technology, leaving other sectors underserved.

• Information Scarcity: Limited transparency and challenges in risk assessment with private credit can lead to capital misallocation and market instability, increasing the risk of defaults and financial shocks.

How to manage multiple risks in an evolving credit landscape?

CONTACT US FOR TIMELY ANALYSIS

Equip yourself with up-to-date knowledge to navigate potential shifts

Sourse: Based on “The Credit Markets Go Dark” by Jared A. Ellias and Elisabeth de Fontenay (2024)