Dealmakers from Carlyle to KKR are leaning into the $7.4 billion private-credit market — but higher demand for the opaque space has only made it riskier

  • Private-credit funds raised $143 billion last year and are keen to put that money to work.
  • Firms such as Carlyle and KKR are bolstering their private-debt offerings as M&A opportunities rise.
  • Borrowers can arrange private loans faster, but this comes at a greater cost to companies.
  • See more stories on Insider’s business page.

Private-credit funds have garnered a few monikers over time. Direct lenders, club dealers, nonbank lenders, and even shadow bankers.

As the latter suggests, it’s an opaque part of the debt markets that’s grown remarkably as money-center banks such as Citi and Bank of America remain hamstrung by regulatory requirements after the 2008 financial crisis.

Out of the ashes, private credit has soared, often stepping in where big banks cannot. Companies such as Airbnb and the publisher Gannett have turned to private sources for liquidity needs as banks have tightened their purse strings.

But going private, over a syndicated loan or high-yield bond, is not without risk. While these lenders can complete a deal quicker than a bond or leveraged-loan sale, companies are likely to pay up for that expediency. Direct lenders, after all, are taking a chance on something a bank may not, and they want to be compensated for that.

With so much liquidity in the system, investors — from private-equity giants to boutique credit shops — are doubling down on private-credit opportunities as they search for greater returns. Earlier this month, Apollo raised $1.8 billion for its Origination Partnership direct-lending fund, while KKR hired two new managing directors to its private-credit team last month on the back of growth in private lending.

Private-credit funds have raised $32.7 billion so far this year, on top of $143.3 billion last year, and $141.8 billion in 2019, the research firm Preqin reported. Total assets under management in private markets grew 5.1% to $7.4 trillion in 2020, McKinsey said in a report published this month.

“In 2008, a lot of people didn’t know what private debt was. Today, it’s a part of a portfolio’s allocation,” said Mark Jenkins, the head of global credit at The Carlyle Group.

Jenkins, who joined Carlyle in 2016 from the Canada Pension Plan Investment Board, oversees a division that has expanded its assets under management to $53 billion in 2020, up from $29 billion in 2016, Insider reported in January.

The cost of convenience

One of private debt’s biggest draws is the ease of execution. Borrowers deal with a handful of lenders on the structuring, terms, syndication, and finalization of a private loan rather than the many investors that pile into bonds or leveraged loans.

Restructurings, too, can be negotiated behind closed doors with a single lender, or a club of lenders, sparing borrowers the wrath of creditors wanting their money back from defaulted securities.

And while the cost of borrowing from private-credit shops is higher, lenders typically hold the debt for the life of the loan, avoiding the volatile seesaw nature of public markets.

“A direct-lender financing involves less complexity than a broadly syndicated transaction. It’s faster to market, there is no ratings process, and you’re not subject to public-market volatility,” said Anne-Marie Peterson, the managing director and head of debt advisory for the investment bank Baird.

But a surfeit of capital has led to some convergence between private debt and its more publicized cousin in the leveraged-loan market.

As investors demand more supply, terms of the loans — such as borrowers’ debt levels, interest rates, or dividend allowances — have skewed in their favor. And these loans, known as “covenant lite” because they have weaker protections, have inched toward the private-credit space.

“As the market has gotten stronger, pricing has come back down, and we’ve started to see covenant-lite invade the direct-lending market,” Peterson said. “There’s a ton of liquidity available right now, and firms have capital to deploy.”

Another concern, given private credit’s growth since the financial crisis, is whether it’s battle-tested to withstand bouts of economic volatility. But given how quickly the market rebounded in the wake of the pandemic, and the increased amount of capital at their disposal, private-credit shops are confident the space will excel.

“Direct lending has been stress-tested through the pandemic so far. Defaults are also lower as it’s easier to negotiate with a borrower when compared to a broadly syndicated loan,” Carlyle’s Jenkins said. “And recoveries can also be higher because middle-market sponsors are generally more constructive at putting equity into an investment than are large-cap sponsors.”

Investors go where the returns are

In such smaller, bespoke private-credit transactions, returns on investments still outweigh what’s on offer in the bond and leveraged-loan markets.

Apollo’s Origination Partnership direct-lending fund, for example, is seeking an internal return of between 8% and 10%. Private-credit managers also said they typically rake in more than 7% in returns from their investments, while some bank double-digit returns on riskier bets.

Leveraged loans offered an average yield of 4.2% during the fourth quarter of last year, and 3.6% in the first quarter of 2021, the data-provider firm Refinitiv said.

“We have to be comfortable holding our investments to maturity, even if there are shocks in the economy. We need a significant amount of time diligencing each loan opportunity,” said Sengal Selassie, the managing partner and CEO of asset manager Brightwood Capital Advisors. “In a low-rate environment, private credit is more attractive for those looking for yield.”

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