Interview
The Boom in Private Credit
- Global private credit assets currently total approximately $1.2 trillion, with direct lending comprising roughly 40% of the segment.
- The private credit market size is now comparable to established public markets, specifically the high-yield bond market (
$1.6 trillion) and broadly syndicated leverage loans ($1.4 trillion). - A structural shift has occurred where private credit has evolved from a "lender of last resort" to a "lender of first choice" for borrowers, a transition accelerated by bank retrenchment during the Global Financial Crisis and current market volatility.
- Direct lending involves originating loans without intermediaries, allowing borrowers to negotiate final pricing upfront and avoid syndication risks associated with the 2-3 month window between bank underwriting and market placement.
- Private credit offers bespoke, flexible financing structures (e.g., acquisition facilities) without mandatory credit ratings, enabling faster execution and greater confidentiality compared to public market issuance.
- Borrower profiles have expanded significantly, with direct lending transactions now frequently exceeding $3–4 billion, including companies that could historically access public debt markets.
- The investor base has diversified beyond traditional sophisticated institutional investors (pensions, insurance, sovereign wealth funds) to include retail-accessible vehicles, driven by the asset class's track record of lower volatility and superior risk-adjusted returns since 2010.
- Approximately two-thirds of private debt investors are net liquidity providers, meaning the asset class is well-structured for holders who do not require daily liquidity, mitigating typical illiquidity concerns.
- In the current macro environment, direct lending is exposed to higher interest rate risk than public fixed-rate bonds because loans are typically floating-rate, creating immediate funding cost pressures for borrowers over the next 2-3 quarters.
- Goldman Sachs notes that public bond markets have extended maturities materially over the last two to three years, providing a differential in resilience against aggressive hiking cycles compared to private credit.
- Unlike the 2008 crisis where sponsored companies underperformed, post-2020 data shows high-yield bonds issued by companies with private equity sponsors outperformed non-sponsored peers due to the market viewing sponsor backstops as assets.
- Investment strategies are shifting toward sectors with strong pricing power and essential service models, specifically healthcare, software (ERP), and business services, while avoiding commodity-exposed manufacturing.
- Rising defaults are expected among borrowers unable to grow out of high capital structures in an environment of rising rates, leading to differentiated performance across the asset class.
- Significant investment opportunities are emerging from three sources: $3x growth in private equity dry powder since 2008, banks retreating from underwriting due to volatility, and the need for balance sheet restructuring by companies raised capital in previous cycles.
- Current private credit assets under management include nearly one-third in "dry powder" (uninvested capital), though inflows may slow as public market yields have reset (high-yield averages rising from 3.75% in June 2021 to 8.5% currently).
- The asset class is demonstrating increased depth, evidenced by large-scale LBOs being entirely funded on the private side, challenging the previous paradigm that private markets were niche for small issuers.
- Goldman Sachs rejects the characterization of private credit as "shadow banking," citing low leverage levels (significantly lower than the 15-30x structures of the 2006-2007 period) and minimized asset-liability mismatches compared to pre-GFC conditions.
- Direct lending funds operate with locked-in capital matched to loan maturities, reducing the systemic risk of balance sheet mismatches that drove the 2008 deleveraging shock.
- Future regulatory scrutiny is anticipated regarding transparency and disclosure as private credit products are sold to retail investors, though governance and due diligence standards are argued to be higher than in public markets.
- Latvi Kheri notes that systemic risk remains low relative to the broader credit complex, with direct lending (including dry powder) valued at roughly $0.5 trillion compared to the $6.5 trillion investment-grade bond market.
- Primary risks identified include the potential for reduced returns in the current cycle compared to historical performance and the possibility that large pension funds may lack sufficient diversification across asset classes if private credit becomes a significant portion of their portfolios.
- The conversation occurred on June 21, 2022, with market forecasts and data corresponding to that date.