Tighter lending conditions and the impact of Silicon Valley Bank’s collapse caused traditional lenders to adopt a more cautious stance in 2023. Many borrowers subsequently turned to private credit as a means of raising finance. Private credit, for example, gained a significantly increased share of the loans supplied to the leveraged buyout (LBO) sector in 2023.

Despite the likelihood that interest rates have peaked and may begin to ease in 2024, demand for private credit will likely continue to grow and banks may struggle to win back business. Indeed, Preqin forecasts that assets under management in private credit will reach US$2.8 trillion by 2028—almost double the 2022 figure.[1]

Banks may now have an increasing advantage over direct lenders in terms of cost—refinancing in the syndicated market is currently 75 basis points cheaper than the unitranche alternative, while financing for new M&A is 100 basis points cheaper, according to bankers quoted by Bloomberg in January.[2]

However, Bloomberg adds that incumbent direct lenders also have the right to pitch a repricing to the borrower, and may offer lower rates, higher leverage, or undrawn acquisition lines to keep hold of a deal. The news agency says that private credit firms have indeed been slashing their pricing to win deals.

Banks face other hurdles. The adoption of new regulations, such as the updated global Basel III regulations that come into effect in 2025, could force many banks to reduce lending further and jettison some of the loans—residential, commercial, and corporate—already on their balance sheets. That will encourage more and more companies to tap private credit markets.

In addition, direct lenders can be much more flexible than investment banks et al. Regulations can limit the amount that banks can lend, for example. In the EU, they are required to limit leverage on deals to six times, while direct lenders can push leverage much higher.

Attractive opportunities for investors

The research firm Preqin says in its 2024 global report on private debt that investors are seeking the stability and higher returns offered by private debt, while fund managers are capitalizing on the opportunity by launching new funds and targeting larger pools of capital. Preqin believes that “amid economic uncertainty, private debt is proving to be a compelling investment option.”[3]

Although interest rates may have peaked, the outlook for inflation and borrowing costs certainly remains unclear. The US economy, for example, may continue to confound expectations, having grown by nearly 3% in 2023 despite expectations that it would fall into recession. Then there are the geopolitical threats, including the potential disruption to global shipping lanes and oil supplies from the Middle East, which could further fuel inflationary pressures.

Maturity wall brings risks… and opportunities

Interest rates are also unlikely to fall back to the abnormally low levels seen prior to 2022. Those companies and consumers that borrowed when rates were low will have to refinance at much higher rates. The impact of higher borrowing costs on profitability has already been seen in commercial real estate, and other sectors could follow suit in 2024. That said, repricing in the real-estate sector could now be creating opportunities for investors, and similar trends could be seen in other sectors going forward.

In conclusion, the private credit sector will likely enjoy another year of strong growth as banks continue to adopt a cautious approach to lending and companies seek to refinance loans taken out at very low borrowing costs. Investors are likely to face outsized risks and opportunities compared with earlier years, and a selective approach on a geographic and sectoral basis is warranted. However, the fact that demand for capital will likely outpace supply indicates that investors should be able to find attractive opportunities without taking on significant risk.

Key takeaways

• Demand for private credit is likely to continue to grow strongly in 2024 as banks continue to adopt a cautious approach.

• The stability and higher returns offered by private debt will continue to attract investors to the sector.

• Compelling opportunities for investors are expected to emerge over the course of the year.

Sources

[1] Banking Exchange

[2] Bloomberg

[3] Banking Exchange