Andrew Edgell, Global Head of Credit Investments at CPPIB, photographed at CPP Investments office in downtown Toronto on Dec. 7.Jenna Marie Wakani/The Globe and Mail
A boom in private credit looks poised to continue in 2024, as institutional investors grab an ever larger share of the debt market from banks, even though mounting headwinds threaten to make more borrowers buckle under the weight of rising costs.
Amid a slump in private equity and real estate deals, many large investors have shifted their gaze to private credit – a kind of debt provided by non-bank lenders, usually at floating interest rates, that is not traded in public markets.
With competition from banks sagging and returns from loans driven higher by a rapid jump in interest rates, the amount of global private debt assets under management has increased by more than 50 per cent, surpassing US$1.6-trillion in 2023. By 2028, that sum is expected to surge to US$2.8-trillion, growing at a compound annual rate of 11 per cent, according to projections from investment data company Preqin.
Global private debt assets
under management
Trillions of U.S. dollars
Actual
Forecast
$3.0
2.5
2.0
1.5
1.0
0.5
0
‘16
‘20
‘24
‘28
‘12
‘14
‘18
‘22
‘26
2010
THE GLOBE AND MAIL, SOURCE: PREQIN
Global private debt assets under management
Trillions of U.S. dollars
Actual
Forecast
$3.0
2.5
2.0
1.5
1.0
0.5
0
2016
2020
2024
2028
2012
2014
2018
2022
2026
2010
THE GLOBE AND MAIL, SOURCE: PREQIN
Global private debt assets under management
Trillions of U.S. dollars
Actual
Forecast
$3.0
2.5
2.0
1.5
1.0
0.5
0
2016
2020
2024
2028
2012
2014
2018
2022
2026
2010
THE GLOBE AND MAIL, SOURCE: PREQIN
Investors and analysts alike have called it a “golden age” for private credit, predicting the size of the asset class will surpass the traditional bank market for syndicated debt. A structural shift in loan markets is already evident: As many banks, especially in the United States, have been confronted with tighter regulations, higher capital requirements and constraints on liquidity, they have reined in their lending. Private lenders have rushed in to fill the void.
“We’re in this transition phase. I’m not sure anyone knows exactly where it’s all going to land, but there is a paradigm shift happening right now,” said Andrew Edgell, global head of credit investments at Canada Pension Plan Investment Board (CPPIB), in an interview. “Credit risk is going to sit in different places than it did historically.”
The conditions that have made private credit such a lucrative opportunity, however, are starting to show signs of strain. A rush of new private lenders raising funds and allocating more money to private loans have created much stiffer competition, and the generous rates lenders could charge for loans have started to inch downward.
Meanwhile, a coming bulge of maturing loans will need to be refinanced at higher rates: Preqin estimates US$325-billion of leveraged loans will come due in 2025 and 2026, and investment manager PIMCO forecasts that US$3.6-trillion of commercial real estate loans in the U.S. and Europe need renewing by 2025. This presents both opportunities and risks for lenders.
The higher lending rates that have made private loans so lucrative are starting to put serious pressure on some borrowers. This is pushing the number of defaults higher and forcing cash-strapped companies to look for relief.
Ratings agency Fitch is predicting an increase in private credit defaults, and industry executives said that a cycle of higher losses on private loans has already started, though the default rate is still comparatively modest so far. In Canada, some private debt funds have limited redemptions as available as they ran short on available cash to pay out to investors.
“It’s a double-edged sword because, on the one hand, we’re getting better yield as investors, but on the other hand, it is slowing growth in the economy and it’s slowing growth at the company level because companies are having to use that excess cash flow for debt service,” said Nayef Perry, head of direct credit at investment manager Hamilton Lane, in an interview. “And they don’t have excess capital for capital expenditures and growth as a result.”
Over the past two years, conditions in the loan market swung heavily in favour of private lenders, turbocharging the market’s expansion. Benchmark interest rates that form the foundation of most private loans – such as the secured overnight financing rate (SOFR) – surged from near zero to 5.3 per cent. Then, early last year, U.S. banks that had already been pinched by tighter regulations saw liquidity dry up after Silicon Valley Bank collapsed.
As banks pulled back, private lenders with dry powder stepped in and the spread they could charge above SOFR approached seven percentage points, according to Preqin. That meant many private loans, which typically have floating interest rates, promised returns of nearly 12 per cent, secured by assets and first in line in the event of a default.
“When you can sit at the top of the capital structure and earn 10 to 12-per-cent yields in some of the safest places in investing, there are not too many other places you’d rather be when you wake up in the morning,” Mr. Perry said.
For the foreseeable future, the prospects for private credit still look attractive and investors are adding to their portfolios. At CPPIB, which did its first private debt deals in 2009, Mr. Edgell has watched credit assets under management grow to $62-billion today, about 70 per cent of which is private credit. By 2029, CPPIB aims to nearly double the size of its credit portfolio to more than $115-billion.
But the conditions in private debt markets are starting to tighten, as central banks signal that rate cuts could be on the horizon. The typical spread on private loans has narrowed to between 500 and 650 basis points – or five to 6.5 percentage points – meaning private lenders now often earn 9 to 11 per cent on new credit.
Those are still very strong investment returns, but they come with more caveats than there were a year ago. The market for leveraged buyouts is still slow, a larger array of funds are racing to put money they have raised to work, and banks are gradually coming back to the market with more conviction. Now, when deals do come up, it’s not uncommon to see “everyone piling in,” Mr. Edgell said.
“All of a sudden, even the private lenders are competing over price, and even the covenants start to go as well,” he said. “It is a competitive market.”
Some major investors have sought to tamp down concerns that the private debt market looks frothy. They note that the size of most loans are much lower, relative to the value of the assets underlying them, than they were in the exuberant lead-up to the 2008 global financial crisis.
“You see this large growth in the asset class and the assumption is maybe there’s an excess and people are taking undue risks. And I would say when you actually look at what’s happening, that’s not the case,” said Jonathan Gray, president and chief operating officer of Blackstone Group, in an interview in September.
Instead, a split is emerging in the private debt market: Companies that took on responsible amounts of debt and have been able to pass rising costs from high inflation on to consumers by raising prices have seen their cash flows hold up, while companies that borrowed more heavily and have revenues that haven’t kept pace with expenses are starting to suffer.
The watchword in private credit now is discipline, as sound underwriting is seen as the best way to sidestep pockets of stress showing up in credit markets.
“We’re definitely going through a default cycle. And we’ve got things we’re paying closer attention to in our portfolio. But we’re actually really benefiting right now from underwriting and putting a lot of resilient positions on the book,” Mr. Edgell said. “We aren’t seeing as much stress as you might think and cash flows are holding up.”
The private credit market “will just continue to grow dramatically,” he said. In that environment, “we have to be maniacal about underwriting and day in, day out, we just have to grind it out.”