Private credit is an increasingly popular asset class among allocators, owing to its high yields, but many investors have sounded warnings lately that it may be too risky. For instance, Jamie Dimon, CEO of JPMorgan Chase, has warned that an economic downturn could slam this relatively new asset class.
A bigger threat to private credit may lie in continued pullbacks of bank lending, especially to smaller businesses, according to a paper by debt investment firm Turning Rock Partners, published by the National Conference on Public Employee Retirement Systems.
Lower-middle-market companies, defined as those with less than $1 billion in enterprise value (market value plus debt value minus cash), could have a lot of difficulty if small bank lending—where most small businesses get their credit—drops by 5%, the paper stated. That would exceed the current private credit lending capacity, the authors wrote.
Absent such a scenario, however, the investment opportunities of private credit are robust, according to the paper. With annual yields of around 10%, more than double what 10-year Treasury bonds pay, it has become very attractive to institutional investors.
Of lower-middle-market businesses, “28,000 have revenues of $50-$250 million,” the paper noted. “At an assumption of $20-50 million in capital need per company, the market demand over the next three years could easily exceed $3 trillion.” Private equity firms, such as Apollo Global Management, stepped in to offer the loans as banks have reduced lending.
So private debt thus far has seen rapid growth, reaching $2 trillion globally as of mid-2023, up from $280 billion in 2007, according to PitchBook. The sector used to be the province of private equity, which borrowed for buyouts, but now has expanded to operating and capital loans for stand-alone companies, mostly on the small side; these now make up almost half of all private lending.
There is some worry that the private debt field may be getting crowded, with too much capital seeking too few opportunities. Stephanie Rader, global co-head of alternatives capital formation of Goldman Sachs Asset Management, in a video presentation, disagreed.
Borrowers are increasingly demanding these loans, she said, because they “see the benefits of this bilateral relationship with a private credit lender—including speed, flexibility and certainty of execution.”
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Dimon Sounds Alarm on Private Credit—Sounds Like Junk Bonds, Circa 1990
Private Credit Downgrades Rise Among Mid-Sized Companies, Says KBRA
Tags: Apollo, bank lending, Goldman Sachs, National Conference on Public Employee Retirement Systems, PitchBook, Private Credit, Turning Rock Partners