The Rise of Private Credit

There’s something discomfiting about the rise of private credit. 

Banks and government regulators have expressed concerns that this type of lending is a bad idea. Banks found the delinquency rates and deterioration in credit quality, especially of sub-investment-grade corporate debt, to have been unexpectedly high in both the 2000 and 2008 recessions and have reduced their share of corporate lending from about 40 percent in the 1990s to about 20 percent today. Regulators, too, learned from this experience, and have warned lenders that a leverage level in excess of 6x debt/EBITDA “raises concerns for most industries” and should be avoided. According to Pitchbook data, the majority of private equity deals exceed this dangerous threshold. 

But private credit funds think they know better. They pitch institutional investors higher yields, lower default rates, and, of course, exposure to private markets (private being synonymous in some circles with wisdom, long-term thinking, and even a “superior form of capitalism.”) The pitch decks tell of how government regulators in the wake of the financial crisis forced banks to get out of this profitable line of business, creating a massive opportunity for sophisticated underwriters of credit. Private equity firms maintain that these leverage levels are not only reasonable and sustainable, but also represent an effective strategy for increasing equity returns.

Which side of this debate should institutional investors take? Are the banks and the regulators too conservative and too pessimistic to understand the opportunity in LBO lending, or will private credit funds experience a wave of high-profile defaults from overleveraged buyouts?

Greg and I have written a major new essay out last week in Institutional Investor that seeks to frame and answer this question.  I also recorded on interview with RealVision about developments in the private credit market, which was covered by the Financial Times.  Please click on the links below to read the full article, watch the interview, and see how the Financial Times is covering our analysis of the private credit market.