Private credit is now a globally established source of mainstream finance for borrowers around the world, with the industry on-track to grow to USD1 trillion of assets under management by 2020.
That’s according to new research published by the Alternative Credit Council (ACC) – the private credit affiliate of the Alternative Investment Management Association (AIMA) – and global law firm, Dechert.
The ‘Financing the Economy 2018’ report draws on an industry wide, international survey of nearly 70 private credit managers with a collective total of USD470 billion of private credit assets under management across a broad cross-section of jurisdictions and strategies. The report comes as the Financial Stability Board, Chaired by Bank of England Governor Mark Carney, recognises market-based finance with the new term ‘non-bank financial intermediation’.
While half of respondents’ capital (51 per cent) is allocated to SMEs or mid-market borrowers – more than ever before – managers are also increasingly lending to a far wider variety of borrowers outside of the mid-market: from smaller businesses and start-ups, to larger corporations, real estate and infrastructure projects. One in five private credit managers surveyed provide financing to companies with Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDAs) of over USD100 million and over 40 per cent surveyed are lending to companies with EBITDAs of less than USD25 million.
The investor base of private credit continues to grow, with over 70 per cent of all private credit committed capital now coming from institutional investors, according to the research. The industry’s diversity is offering attractive strategies for smaller or non-institutional investors such as family offices, which account for 5 per cent of committed capital allocated to private credit. 38 per cent of committed capital today comes from North American investors and 31 per cent from Europe (excluding the UK), indicating that the European market is becoming a core region for private credit.
The majority of the private credit managers surveyed have long-standing experience of the sector, with two thirds of respondents having been operating for over six years and 45 per cent for over 10 years; managers are experienced across multiple fund ages and loans types.
Private credit managers continue to provide borrowers with bespoke financing that offers greater flexibility on coupon and covenant terms than traditional bank lending.
The survey data supported this with almost four times as many respondents reporting that arrangement fees are decreasing rather than increasing. Twice as many respondents reported financial covenant protection weakening than strengthening over the past year. The picture on loan coupons is more nuanced, with a third of respondents reporting that coupons have lowered over the last 12 months.
However, while private credit managers may be showing more flexibility around covenants than in previous years, there are still risk baselines they will not cross.
Private credit managers expect continued growth across the asset class, with more respondents predicting to increase their allocation, rather than decreasing it, across every sub-sector of the private credit market. Optimism is highest across SME and mid-market lending, where a third of respondents plan on increasing allocations over the coming three years. Respondents anticipate nearly the same amount of growth in the distressed debt market, expecting that interest rates will rise making it harder for some borrowers to meet their existing loan commitments or refinance.
However, managers are also preparing for the possibility of an end to the current credit cycle and tougher economic conditions for borrowers. As such, managers are increasingly lending at positions higher in the capital structure and moving away from cyclical sectors.
Capital continues to be put to work with dry powder – also known as available capital – remaining at approximately one-third of the industry’s total assets, which is below the sector’s long-term average.
Financing is being used sparingly, with more than half of all managers and investors surveyed preferring unleveraged private credit strategies. Where leverage is used, it tends to be at relatively low levels, although those levels have risen slightly over the last year.
The capital invested in private credit funds is matched to the needs of borrowers in the real economy. Nearly 66 per cent of surveyed managers use closed-ended commitment and drawdown fund structures. This benefits the financial system by ensuring that borrowers know they can put money to use for the whole period pre-agreed with the private credit fund manager. This means borrowers can be more certain of financing in times of market fluctuations, as funds cannot be withdrawn by investors.
Jiri Krol (pictured), Deputy CEO, of the ACC, says: “It’s exciting to see the continued growth and success of our industry both in terms of geography, different strategies and underlying asset classes. We are now being recognised as an important and unique source of finance by the policy makers. That said, most in the industry are thinking about what happens next in the cycle as the era of extremely loose monetary policy slowly comes to an end.”
Stuart Fiertz, Chair of the ACC, says: “Over the past decade, private credit has moved from a niche form of lending to a mainstream and integral form of financing. At the same time, it has matured into a standalone asset class incorporating a range of strategies and types of funding. This survey is the biggest and most comprehensive to date and will provide greater transparency on our activity to the market, the investors and the regulatory community. We believe this will be important as the cycle turns, to ensure we maintain standards, remain disciplined and be responsible stewards of capital over the long term.”
Gus Black, Co-Chair of the Financial Services Group at Dechert LLP, says: “Once again, we are very pleased to support this report, which gives a good sense of the important role private credit now plays in funding the real economy.”
