Private Credit Growth
Managers of private lending funds are bringing in more cash than they know what to do with. This industry has seen extreme growth in recent years, now valued at over $2 trillion, from $1 trillion in 2020, and will continue to see growth with projections of $2.8 trillion by the year 2028.
What is Private Credit? Private credit refers to private loans between a borrower and a non-bank lender. These funds allow borrowers access to capital and customizable lending terms that may not be available from a traditional lending institution. Many times, these loans will have floating interest rates unique to the borrower and lender. This makes up most of private credit, but it also contains asset-backed finance, loans backed by physical collateral such as real estate or machinery.
Private credit carries a variety of risks:
Illiquidity: can’t be traded or bought like regular bonds.
Credit-Risk: Much of this lending is subprime, which means borrowers have a higher risk of default.
Crowding: Many investors are interested in high yields, resulting in underwriting standards falling.
Opaque: Lack of regulation and no jurisdiction. Investors and regulators can’t see the full picture.
These risks are evident, as now roughly 1/3 of borrowers have interest costs exceeding their current earnings. If interest rates stay high or the economy slows, defaults could spike, causing systemic ripples. Some experts warn that if it continues to see exponential growth without oversight, it could become a major source of financial instability in the next downturn.
Despite this, private credit has been one of the fastest-growing asset classes in recent years. The introduction of it stems from increased regulation and worry around banks’ lending to businesses after the 2008 financial crisis. Now, amid tighter bank lending, borrowers value the speed, certainty, and flexibility of lending offered by private credit. U.S. direct-lending fundraising saw compounded annual growth rates of roughly 25% in the 2010s, but in the past four years, it has seen rates of close to 40%. It has also seen extreme growth in developing markets by up to 90%.
While private credit offers value in a world of tight bank lending, its growth is raising some concerns. Small and mid-sized companies are benefiting from access to capital, but at what cost? Without transparency, diligent underwriting, and thoughtful regulation, Private Credit and its extreme inflows of cash from pensions and insurance may not be able to handle the consequences.