Private Credit ‘at a Crossroads’ in 2023

Although the private capital market continues to thrive, it “finds itself at a crossroads” and is “flashing warning lights on many key metrics,” according to a report from international law firm Proskauer Rose LLP.

The basis of the report is a survey of more than 150 executives at private credit firms worldwide, seeking their views on the state of the direct lending market in 2023. The executives were asked about their expectations for the year, including factors driving deal flow and challenges for dealmakers.

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According to the report, “worries about the wider economy, deal activity, defaults, check sizes and dry powder” are among lenders’ biggest concerns.

Although 99% of respondents said they are actively looking for new lending opportunities, 55% said they expect deal activity to slow down, nearly twice as many as who held the same opinion in last year’s study. Inflation and macroeconomic risks, dry powder and sponsors seeking realizations were among the most important drivers of deal flow, according to the report.

The survey found that business services and the combined software and technology category were the most popular investment targets, with 94% of respondents saying they would consider investing in those two sectors over the next 12 months. Health care was also a major prospect for investors, with 90% expressing interest.

However, there were significant differences in terms of sector preferences based on the respondents’ locations. For example, European executives were far more likely to consider investing in education than U.S. respondents. There was also significantly less interest in manufacturing and transportation and logistics among European respondents than among those from the U.S.

According to the survey, environmental, social and governance factors are a major consideration for the vast majority of respondents, with 84% saying they consider ESG factors for every investment; another 9% said they consider it on at least some investments.

“The focus on environmental, social and governance factors in the private credit industry has accelerated in recent years, and it continues to gain momentum as best practices develop,” the report stated. “There has been a shift to socially conscious investors who demand transparency, and climate change and diversity, equity and inclusion considerations remain priorities for managers.”

Among U.S. respondents, 90% said ESG considerations were present for all or some cases, while that figure was 100% among European respondents. However, the two regions diverge sharply when it comes to offering interest rate ratchets to borrowers to meet ESG goals, with 94% of European respondents saying they do, and 73% of U.S. respondents saying they do not.

Despite the concerns about the private credit climate in 2023, the survey respondents also said they believe the market is still very resilient and that lenders are still willing to lend, raise capital and are strategically seeking new investment opportunities.

“Clearly, while there are storm clouds gathering over the $2.18 trillion private credit market, lenders do not seem to be tapping the brakes too hard … yet,” the report concluded.