Attractive Yields and Conservative Structures Can Create a Compelling Vintage in Private Credit

We believe private credit, and direct lending in particular, will continue to deliver tangible value to both investors and borrowers. Today, investors have benefited from the higher returns, consistent cash flows and steady income distributions that private credit can provide while seeking to deliver lower volatility. At the same time, borrowers have appreciated the partnership that a private credit manager can provide with certainty of execution and no direct market risk for the borrower due to the committed capital and contractual commitments that underlie such financings. These factors increasingly make private credit borrowers’ lender of choice.

Banks continue to retrench from middle market lending with private capital providers filling the void. Record levels of investible capital amassed by private equity sponsors, as well as the growing volume of refinancing’s, growth capital and dividend recapitalizations, continue to drive demand for private credit. Private equity dry powder far exceeds the available debt capital needed to support projected buyout activity.

In our view, this secular shift is occurring against a backdrop of more conservatively structured loans with lower leverage levels, higher equity cushions and greater lender protections in credit agreements.

Implications for investors considering private credit

In a benign credit environment, there are typically low default rates and little dispersion of returns among managers. In fact, managers that took on more risk have been typically rewarded with more return. But we are no longer in a period of benign credit. Higher rates are a double-edged sword: the higher returns due to lenders must come from somewhere, and it is being paid for by the borrower. And the risk of a recession is top of mind for investors and managers alike, with concerns over earnings pressure and a potential increase in defaults. Periods of economic stress and higher interest rates will differentiate true credit investors from mere asset gatherers and may result in a greater dispersion of returns across managers.

Against this backdrop, it’s clear that experience matters. Investors considering private credit today should consider a manager’s experience investing across multiple credit cycles (including through prior high interest rate environments and periods of economic weakness), strength of sourcing platform, consistent discipline in underwriting and portfolio management expertise.

We believe that with the right manager, the attractive yields and conservative structures today should create the conditions for a compelling vintage in private credit.