Private Credit Market update

Private Credit Outlook for H2 2024: Growth, Challenges, and Market Dynamics

As we move into the second half of 2024, Federated Hermes forecasts a challenging period for the private credit market . Rising debt costs and persistent inflation are expected to increase defaults and stress debt covenants, particularly for funds with aggressive loan structures. Investors may shift towards more conservative strategies, making fundraising tougher for these funds. Strong companies are likely to secure favorable loan terms, while weaker ones will face higher costs and stricter conditions.

Pitchbook reports that key macroeconomic trends from last year continue to influence the market: robust labor markets, rising stock markets, and ongoing investor attention on the Fed’s potential rate cuts. The strong US economy and persistent inflation have led to revised expectations for Fed policy rates. Dealmaking remains sluggish, with LPs and GPs exploring fund secondaries, NAV lending, and other innovative solutions for liquidity. Traditional exit routes might become more viable if the economy remains strong and interest rates decrease.

The latest Pitchbook Allocator Solutions report provides a deep dive into potential economic scenarios and their impact on private market investments, comparing current risk and return expectations to the zero-interest-rate period of 2021. It highlights high buyout entry valuations, constrained VC capital supply, increased competition in private credit, and neutral real estate valuations, emphasizing the need for caution against static NAVs in evergreen funds.

Fed Report on Private Credit

The Fed reports that since 2000, the private credit market has seen significant growth (see left panel of graph from Preqin ), reaching nearly $1.7 trillion and rivaling the leveraged loan market ($1.4 trillion) and the high-yield bond market ($1.3 trillion). Direct lending (as shown in the right panel of the graph) has been a major driver of this growth, totaling $800 billion, or about half of the overall private credit market. Additionally, the increase in committed but uninvested capital, or 'dry powder,' suggests that the supply of private credit is currently surpassing the demand for private loans.

As we navigate these trends, the private credit sector is set for a dynamic period of growth and adjustment.?

Also, the Fed Report noted that the private credit sector is heavily concentrated in a few large fund managers such as Oaktree, Ares, Goldman Sachs, HPS Investment and Blackstone. A large share of dry powder is also held by the top 5 fund managers, suggesting disproportionately high demand for these fund managers by LPs. Fed staff estimate that top 10 U.S. private debt fund managers hold about 40-45 percent of all dry powder in the U.S., across all private debt strategies (per the report, this calculation is based on a 25-30 percent dry powder assumption and a 61 percent market share of U.S.-based funds, which is sourced from PitchBook .)

Recent Developments and Deals

• To navigate interest-rate volatility, private credit fund managers are increasingly adopting perpetual nontraded business development companies (BDCs) for long-term investments. Unlike traditional BDCs, these perpetual BDCs do not have a fixed end date and are not publicly traded, which allows for ongoing capital raising and flexible investment strategies. This model has led to substantial growth, with perpetual nontraded BDCs representing 42% of all BDC assets and helping to achieve a record $315 billion in total BDC assets for 2023. While they offer stability and the potential for high returns, they also come with risks such as limited redemption options and complex valuations. The private credit market is expected to keep expanding, with some forecasts predicting it could reach $40 trillion by 2028.

• Regulators are worried about significant risks in the private credit market , highlighting that nearly 40% of funds do not have managers investing their own capital, which could create conflicts of interest between managers’ profits and investors’ returns. As the $2.1 trillion private credit sector grows, concerns are rising over the lack of experience among managers with credit cycles and issues with fund valuations, as only 40% of funds use third-party marks. There are also increasing fears about how private credit interacts with traditional banks and shadow banks, which could lead to risky financial entanglements. The future stability of the market will depend on interest rate trends and ongoing efforts to understand these interactions.

• Insignia Financial Ltd. is in the final stages of selecting external managers to invest billions in global private credit markets, aiming to increase its private credit allocation to 3-5% of its A$180 billion retirement savings portfolio over the next year. The fund, managed by MLC Asset Management, will focus on opportunities in the US and Europe as private credit grows due to banks pulling back from risky lending and strong investor demand. Dan Farmer, MLC’s Chief Investment Officer, stresses the need for careful manager selection amidst competition and capital shifts. Other major Australian pension funds are also expanding into private credit, while some, like Rest, are being more cautious. AMP Ltd. has recently increased its international private credit investments as part of a diversified credit strategy.

• Wingspire Capital provided a $60 million senior secured revolving credit facility to Comtech Telecommunications Corp. , as part of a broader $222 million credit package that also included a $162 million term loan managed by TCW Private Credit. This financing allows Comtech to refinance its existing debt while enhancing its liquidity and flexibility. Headquartered in Chandler, AZ, Comtech is a global leader in terrestrial and wireless network solutions, next-generation 9-1-1 services, satellite and space communications, and cloud-native capabilities for both commercial and government clients.

• SLR Credit Solutions has finalized a $65 million senior credit facility for Quantcast Corporation , a leader in AI-driven programmatic advertising. Quantcast's CFO, Imad Tareen, commended SLR CS for their deep understanding of the business and expertise in foreign lending. Tanner Phifer, Managing Director at SLR CS, emphasized Quantcast's pioneering use of machine learning in digital advertising and their promising prospects for global expansion.

If you’d like to discuss any private credit opportunities, you can reach me at [email protected] .

You can learn more about Axis Group Ventures at our website here .?

All the best - Tim