Private Credit

The term private credit refers to loans made directly by non-bank lenders. The sector has grown immensely, from under $500 billion 10 years ago to approximately $1.2 trillion domestically and $1.7 trillion globally. It is currently one of the fastest-growing sectors of the financial system.

Borrowers are typically companies that cannot access public debt markets. Often, these are small- and mid-cap companies carrying significant leverage — many the result of private equity buyouts financed with debt.

Among the largest lenders are Apollo, Blackstone, Ares, Blue Owl, and KKR. These entities create private credit funds using investor capital and leverage to issue loans. These funds charge relatively high interest rates because they have a captive audience; banks, constrained by post-2008 regulations, are often no longer willing or able to provide financing to these firms.

 

Investor Benefits

• High yields: Due to illiquidity, private credit loans offer higher yields than similarly rated bonds in the public debt market.
• Senior security: These loans are often at the top of the capital stack. In the event of default, these investors are the first to be repaid. Furthermore, many loans are collateralized.
• Diversification: Funds diversify by lending across different companies and industries.
• Lower perceived volatility: Because these loans do not trade daily and are only priced quarterly, they are perceived as having lower volatility.
• Floating rate: Most private credit loans have floating interest rates, which helps limit price drawdowns when yields rise.

Investor Risks

• Credit risk: As with all debt assets, the primary risk is default and loss of principal. This risk is elevated not only by the borrower's financial condition but also by the leverage employed by many private equity funds.

• Liquidity: Investors are often unable to sell holdings due to lock-up periods, which are typically five to 10 years. Recently, many funds have limited repayments to levels well below what investors requested.

• Floating rate: While a benefit to the lender, rising rates increase the borrower’s rates, thus increasing the risk of default.

• Lack of transparency: Because these loans do not trade or have a current market price, investors have little insight into their real-time value. As a result, debt prices can drop from par to near zero with no warning.

Private Credit Investors

The largest holders of private credit funds are pension funds, insurance companies, sovereign wealth funds, endowments, and family offices. These are generally accredited, sophisticated investors who understand that the yield premium comes at the cost of illiquidity. In many cases, these investors can absorb significant losses without disrupting the broader system.

Private Credit Investors

The largest holders of private credit funds are pension funds, insurance companies, sovereign wealth funds, endowments, and family offices. These are generally accredited, sophisticated investors who understand that the yield premium comes at the cost of illiquidity. In many cases, these investors can absorb significant losses without disrupting the broader system.