Private Credit Boom Set to Continue Amid Surplus of Capital

The multi-year boom in private credit shows no signs of abating as more investors and capital enter the market, underscoring the need for prudence in deal selection, according to experts speaking at Nomura’s Private Assets conference in London.

The private credit market expanded to about $1.5 trillion last year, up from $1 trillion in 2020. Private debt assets under management are set to reach $2.64tn by 2029, with a 9.88% compound annual growth rate according to industry data provider Preqin.

An oversupply of capital chasing a limited opportunity is causing the emergence of pricing and contractual risks, noted Kamal Nazha, Head of EMEA Private Credit Origination at Nomura in a panel discussion exploring the changing dynamics of private credit markets.

Simon Morgan, Head of EMEA Capital Commitments at Nomura, explained that, in general, the current environment isn’t conducive for providers to price idiosyncratic credit risk.

Morgan also noted that lenders can have a sense of ‘FOMO’ whereby they don’t want to miss out on deals, leading them to weaken covenants.

Morgan pointed out that in a buoyant market like this, size becomes a factor as large portfolios containing hundreds of line items can absorb a few deals going awry, in contrast to the more severe impact on smaller providers.

Alvaro del Barco, Director at Alpha Wave Global said that excess capital flooding into the market is compressing spreads making deals more competitive for providers, on the other hand, it’s a good market for borrowers to negotiate debt and terms.

He sees a type of barbell effect whereby larger funds seek larger tickets, lowering spreads (jumbo deals can be syndicated to 15+ lenders). The mid-market has fewer lenders so they can still get slightly better risk adjusted returns with higher spreads.

Morgan explained that “Copycatting” was fast becoming a theme as “infant” and “adolescent” deals in the $10-50 million EBITDA range seek out the same terms as “adult” deals despite being a different risk proposition for lenders as a $10mn euro EBITDA company with a limited track record and possibly more venture-like characteristics should afford lenders greater protection.

He said that the trend was being exacerbated by developments in the syndicated loan market whereby single ‘B’ names are clearing 300-375bps creating a pricing tension. That compares to private credit that was at 650bps last year and is now 500-575bps.

Del Barco observed that EBITDA requirements are also becoming more relaxed. Two years ago, there was a 15% cap on EBITDA adjustments and now 25% is acceptable. He is also seeing more flexibility around indebtedness but said that lenders have a red line on asking for strong security on borrowers’ assets.

Low Default Rates

Morgan cautioned that the usual warning signs of distress have been dulled due to weaker covenants.

He said that in a distress scenario there’s a huge uncertainty of outcome as on the one hand lenders may hold a zombie credit drained of resources and devoid of sponsor support, so the debt valuation is lowered. On the other hand, as some deals are bilateral and “friends and family” composition, a narrow group of parties can come together to resolve it behind closed doors which offers a “veil of privacy” that makes it harder to form a true picture of overall stress.

Morgan noted that while default rates are not elevated, the potential opacity in the private credit market makes it harder for lenders to properly assess its overall health. This opacity may understate the true degree of stress and default and instil a false confidence.

The Proskauer Index which tracks private credit defaults across senior-secured and unitranche loans in the United States showed an overall default rate of 2.67% in the fourth quarter, a marginal increase compared to the July-August period but still historically low.

Morgan said that lenders could face a further challenge if default rates rise as they may need to “buy in” with new money to preserve their position and claim. For banks, though less so for funds, this may not sit squarely with their mandate as a lender and cause difficulties.

He added that it’s too early to be definitive about whether portfolios will remain resilient as the full effects of rate rises may not have filtered through and tariffs, geopolitical uncertainty, consumer sentiment, and inflation are lingering risks on the horizon.

Evolution of Private Credit

In a rapidly growing market, regulation and product innovation often have to play catch-up. Del Barco said that given the increase in market participants such as insurance companies and retail customers, regulators will probably apply more scrutiny around investor protection, liquidity and leverage.

Last month, State Street and Apollo Global Management launched a private credit ETF to serve retail investors having previously succeeded with the high net worth segment in private equity.

Del Barco predicted that in future, there will be more partnerships between different players. Already last year, over 10 deals were concluded between banks and private credit or two different private credit providers.

Morgan reiterated that the scale of capital ready to be deployed means that it will look for other assets which could lead to a cannibalisation of public or bond market structures entering the private market domain.

In conclusion, Nazha noted that the private credit industry remains attractive with plenty of transactions that meet return hurdles and provide an acceptable degree of protection.

For more information on this topic, please reach out to Simon Morgan or Kamal Nazha.