Private Credit Cashing In | Milken Institute Global Conference 2024

Market Scale and Growth Trajectory

• The private credit asset class has grown at a 20% compound annual growth rate (CAGR) since the financial crisis, with total assets estimated between $1 trillion and $1.5 trillion.
• Goldman Sachs projects a further 25% CAGR growth over the next five years.
• Institutional allocations have shifted dramatically, with pension funds moving from 1-2% allocations historically to approximately 15% in the current environment.
• Investor demographics have expanded beyond traditional insurance companies and sovereign wealth funds to include high-net-worth individuals and retail investors via vehicles like interval funds and VC-ds.

Competitive Dynamics and Bank Convergence

• Private credit and syndicated bank lending are increasingly characterized by coexistence and collaboration rather than pure competition, with 90%+ market penetration in certain segments as banks return post-2022/2023.
• Goldman Sachs leverages its ecosystem of 3,000 anchor clients and 200 global investors to facilitate both competitive and complementary transactions with its own leverage finance arm.
• Competition persists for "shelf space" among wealth managers and RIAs, where firms must compete on return metrics and due diligence rigor against hundreds of peers.
• Market lines are blurring between syndicated loans, direct lending (BSL), and middle-market financing, with direct lending increasingly serving as the primary solution for companies unable to access traditional bank lending due to regulatory constraints.

Deal Sourcing and Niche Opportunities

• Private credit firms are targeting the lower-middle market (companies with < $40 million EBITDA) to avoid Wall Street competition and capitalize on market inefficiencies.
• Specialized sectors such as life sciences are viewed as high-opportunity areas due to being uncorrelated to GDP and featuring high barriers to entry; these deals often utilize structures like delayed draws tied to FDA approvals.
• Asset-backed finance, including NAV (Net Asset Value) lending, is expanding as a solution for private equity funds facing liquidity constraints or life-cycle termination issues.
• Origination remains a critical differentiator, with firms deploying teams of up to 23 originators across eight offices to source non-sponsored deals independently of the M&A cycle.

Risk Metrics, Defaults, and Recovery

• Default rates in the syndicated high-yield market reached over 4.5% in 2023 (excluding distressed exchanges), more than double the prior year, creating arbitrage opportunities for private credit.
• Private credit default rates are currently marketed at 1-1.5% but are expected to converge with high-yield rates over time, driven by the cyclical nature of credit markets.
• Recovery rates in the private middle market are projected to be significantly higher than in the syndicated market due to maintenance covenants that allow for earlier risk detection and intervention.
• Industry participants note that "selective defaults" and covenant defaults are distinct from payment defaults, with incentives to avoid formal defaults leading to potential gray areas in reporting risk.
• The industry is shifting focus from yield generation to capital protection; winning strategies are defined by "losing less money" through superior documentation and covenant structures rather than chasing spread premiums.

Liquidity, Distribution, and Regulatory Outlook

• A key friction point exists between the illiquid nature of private credit assets and the liquidity expectations of retail investors, requiring careful asset-liability matching to prevent forced fund closures.
• The industry anticipates a potential regulatory shakeout if retail investors experience liquidity failures, as regulators prioritize depositor and investor protection over market expansion.
• Growth since 2008 has been partly fueled by post-crisis regulatory arbitrage (e.g., Dodd-Frank capital requirements) that pushed credit assets out of banking balance sheets.
• Future growth drivers include the expansion into asset-backed finance and revenue stream financing, markets previously dominated by banks and insurers.
• Firms are increasingly diversifying funding bases to avoid over-reliance on any single investor class (institutional vs. retail) to prevent forced capital deployment during downturns.

Macro Environment and Investment Returns

• Current SOFR rates (approx. 5.25%–5.50%) have restored attractive absolute yields, with unlevered returns in private credit ranging between 10% and 11%.
• After leverage and administrative costs, net returns to institutional and high-net-worth investors remain robust at approximately 12.5%.
• The M&A market is currently at roughly 50% of 2021 volumes, driven by higher interest rates causing private equity firms to hold assets longer to wait for multiple expansion.
• A significant volume of "zombie capital structures" from 2016–2018 vintages presents opportunities for junior debt and equity injections to de-lever distressed companies.
• While spreads have tightened due to competition, absolute yields remain historically attractive compared to pre-2020 levels, though deployment pressure remains higher than return pressure.