Private Credit: From Mid-Market to Real Economy Financier

The investor base has evolved alongside the growth of private credit markets, expanding from liability-driven insurance funds to pension capital and sovereign wealth funds to individual investors.

A powerful shift is underway in credit markets as private lenders partner with banks to finance real economy assets. This long-term secular trend has helped private credit markets expand rapidly, but we believe that we’re still in its early innings. In our view, there’s a $25 trillion-plus opportunity ahead that can continue to drive tremendous growth and opportunity for our clients.

The Real Economy Opportunity Knocks

To better understand the opportunity, let’s look back at its evolution. The first phase started with corporate direct lending, where lenders financed smaller, middle-market companies. In 2006, that market totaled just $100 billion. Since then, a virtuous circle emerged. Growth in direct lending led to bigger deals, which led to greater growth and today’s global direct lending market, a fully-fledged $1 trillion non-investment grade market capable of financing transactions over $5 billion. (1) This market’s value proposition—speed of close, structural flexibility, certainty of terms and confidentiality—is increasingly apparent to the private equity sponsor community. Periods of dislocation only reinforced this awareness, including Russia’s war in Ukraine and the regional bank crisis and capital market dislocation in 2023. Private capital financed 86% of LBO transactions in 2023, up from 65% in 2021. (2)

The next phase is just getting started. The accelerating shift to private credit has led to increasing partnerships with banks. These mutually beneficial partnerships enable banks to continue originating assets and serving their customers, and they give us at Blackstone the opportunity to provide our clients with high quality loans. Importantly, an even broader base of borrowers has ongoing access to financing with the same private credit hallmarks, including speed, flexibility and certainty of terms.

A good example of the symbiotic nature of these partnerships is our recent forward flow origination arrangement with KeyCorp’s (Key) Specialty Finance Lending group, a leading asset-based lender serving clients nationally across the middle-market, growth capital, transportation, and equipment. (3)

For this next phase, the combination of higher base rates, the shift from banks to private lenders, and the proliferation of strategies to access private credit creates an opportunity that exceeds $25 trillion. (4) Private investment grade strategies including asset-based financing and infrastructure are particularly compelling. The strategies span Blackstone’s high conviction themes, including digital infrastructure, energy transition, and global housing sectors that require large-scale capital to fuel the significant growth underway. For example, within digital infrastructure, we believe ongoing capital formation, mostly investment grade, will finance growth in demand for data centers driven by cloud adoption and the AI revolution. (5) Current expectations suggest roughly $2 trillion of capital expenditure requirements both inside and outside of the US to build and facilitate new data centers over the next five years. (6)

Figure 1: Financing the Real Economy with Private Credit (7)

The Private Credit Advantage for Investors

The investor base has evolved alongside the growth of private credit markets, expanding from liability-driven insurance funds to pension capital and sovereign wealth funds to individual investors. These investors are facilitating the movement of assets from bank balance sheets, which are levered and funded by short-duration deposits, to the end accountholders, who want to hold these assets for life against their long-duration liabilities. In this respect, we like to think of ourselves as being in the storage business; we are effectively underwriting these loans with a view to owning them for our clients to maturity.

We believe there are clear advantages for investors. Direct origination via a private lender means less intermediation, bringing investors closer to the asset, which in turn results in a better yield for the same or lower risk. The economics of private capital are compelling. Currently, direct lending generates double-digit yields on roughly 50% LTV loans with around 300bps of excess yield compared to public loans (Figure 2). (8) And in private high grade, we have generated about 200bps of excess spread to corporates on origination activity year-to-date. (9)

Figure 2: Excess Return Opportunity in Private Credit Today (10)

From an asset allocation perspective, these assets offer diversification to traditional corporate credit, with reduced volatility and low correlation. We anticipate increasing demand for multi-asset credit from institutional accounts so that they can potentially capitalize on opportunities across the broad spectrum. For individual investors, our flagship fund provides opportunities to diversify their existing 60/40 portfolio.

Scaling Up to the Task

Not all private credit managers have the advantages of being part of a large and diverse credit platform, including scale, sector expertise, access to information, underwriting and origination, and value creation. We do, and our scale and breadth of platform enable us to take full advantage of the significant opportunity ahead, especially from underwriting and origination perspectives.

In underwriting, we try to harness the data and the signals across Blackstone to inform our views on where to invest. We also deploy the three S’s in our underwriting approach —seniority, sector selection, and scale.

For origination, we leverage relationships across all our divisions to identify new opportunities while our global presence and deep-rooted partnerships with sponsors, corporates, advisors, and bankers help us create a high-quality funnel of deals. Examples include our lead lender status in Sentinel’s acquisition of the Industrial Fire division of Carrier Global Corporation (11) and our over $1 billion acquisition of credit card receivables from Barclays for our insurance accounts. (12)

Our scale and breadth also help us to capitalize on the risk, collateral and liquidity opportunity set across the private credit universe by nimbly pivoting to the most attractive sectors or strategies at any given time. Access to proprietary data gives us a valuable real-time information relative to our peers, including early reads on macro trends, such as inflation, which in turn informs our investment decisions. With these unique advantages, we build differentiated portfolios within and across each of our private credit verticals.

These attributes should position us well in the months ahead. We believe the low default environment of the past decade kept the performance playing field relatively even, but as more lending migrates from the banks and public markets to the portfolios of private credit funds, we anticipate managers will have portfolios that perform very differently. Larger managers with the necessary scale, resource, and experience, will be best positioned to stand up to the test.

Figure 3: Performance Dispersion Increases Among Private Credit Managers (13)

(Q1’24)

With contribution from Sarah Husband, Principal, Blackstone Credit & Insurance (BXCI).

1. Preqin data, as of December 31, 2023.
2. Pitchbook LCD data, as of July 2024.
3. Blackstone, KeyCorp and Blackstone Credit & Insurance Announce Forward Flow Origination Partnership , as of March 18, 2024.
4. Market size based on BXCI’s internal analysis on a combination of strategies including ABF, Infrastructure Credit, Private Placements, Real Estate Lending, Structured Credit, and Direct Lending.
5. Green Street, “Data Center Insights” as of January 20, 2024.
6. Stephen Allen Schwarzman — Chairman and Chief Executive Officer of Blackstone, 2Q24 Earnings Call, as of July 18, 2024.
7. Market size based on BXCI’s internal analysis on a combination of strategies including ABF, Infrastructure Credit, Private Placements, Real Estate Lending, Structured Credit, and Direct Lending.
8. LTV refers to the approximate leverage through leveraged loans utilized to finance U.S. buyouts over the last 12 months based on data from PitchBook LCD as of March 31, 2024.
9. BXCI Strategic Insurers Portfolio Data, as of 2Q 2024.
10. JPM Loan Index YTM data is as of March 31, 2024. Direct Lending YTM data represents a BXCI estimate and is approximated from prospective and committed deals observed in BXCI’s private credit pipeline for first-lien and unitranche loans, as of March 31, 2024.
11. Bloomberg News, Blackstone Finances Sentinel’s Purchase of Fire Unit, as of March 20, 2024.
12. Blackstone, Barclays and Blackstone Credit & Insurance Agree to Sale of Credit Card Receivables , as of February 27, 2024.
13. As of March 31, 2024, unless otherwise indicated. Reflects Blackstone Credit & Insurance’s views and beliefs as of the date appearing on this material only, which is subject to change. Note: Non-accrual rate is calculated for each BDC as the amortized cost of loans on non-accrual status divided by total amortized cost of the investment portfolio and excludes equity investments in unconsolidated joint ventures and separately managed accounts. Non-accrual status of a given loan is self-reported by each BDC and is intended to indicate when there is reasonable doubt that said loan’s principal or interest will be collected in full. Includes traded and non-traded BDCs.