What happens to Private Credit when things go back to normal?
I am starting my career in credit soon and it’s obviously a halcyon period for direct lending and speciality finance. High base rates and wide spreads have led to significant inflows into the asset class.
When you couple this with the secular trend of bank lending/BSL tightening, we can definitely see some real long term value. But when are there too many dollars chasing too few deals?
My primary concern, maybe because I like to think about the downside, revolves around what happens when the crazy returns on secure lending facilities fall, investors reallocate to traditional asset classes and PE. Also, wouldn’t this mean thinner spreads due to a supply-demand mismatch on lending?
I’m all new to this so I want to better understand where those of you who have been in the industry see it heading.
Cheers!
Uhh... other way around champ... Long bonds yield around their historic average. Just not what they did under the manipulation of ZIRP / QE. This is normal and the last 12 years were aberrant.
Sure. I'm not disagreeing, but how do you reconcile this with the fact that PC is only about a decade old (roughly matching this aberrant period). Within PC, getting S+600+ on 1L w/ low LTVs is pretty unprecedented, right? So, what happens to the space when we go back to historically "normal" rates? Maybe I am misunderstanding something.
PC has been around for the past 25 years at least, through low interest rate and now high interest rate environments. It’s not going anywhere unless banks suddenly stop getting regulated and return to middle market lending
Here’s my thoughts:
Industry - Private credit will consolidate. Megafunds and massive shops will focus on volume rather than securing the most favorable terms. Banks will also increasingly acquire or invest off balance sheet into certain shops. The structural aspects within the MM / UMM will be less favorable overall, but that does not necessarily mean higher loss rates.
Returns - Will remain in line with historical returns. However, deals (especially upper MM) will become even more cov-lite. However, there will be a new industry wide focus on more esoteric credit strategies such as ABL to seek excess alpha.
Fees - GP economics will come down as consolidation occurs, with the exception of specialist lenders (e.g. distressed, ABL, etc.). Groups like Ares alone are asset gatherers and they will cause an industry wide reduction in fees as they scale AUM tremendously (which makes sense for them).
Issue most PC shops have rn is no one wants their expensive capital so deploying into investments is tough. Waiting for come back to normal so deployment can be fun again.
Let me reframe this from a career standpoint.
You're early in your career so your goal is building skillsets. PC offers the ability to developed a more diversified and transferable skill set than public market credit (I'm on the public side, so I'm not pumping my own tires). In addition to the underlying credit work, you will be helping with term sheets, managing processes such as amendments, workouts, sometimes consultants, etc. Interaction with management will be significantly greater. Whereas public credit is much more just the credit work.
So even if the PC credit asset plateaus, or even declines, you'll be setting yourself up with a nice toolbox to work with.
Thanks!
You should be more concerned about PC AI in the next 2-5yrs. I can't give too much away but I am an insider on the topic.
What lol
Have the robots got money to lend?!
x
My view is that DL will continue to grow. As time has shown us, traditional banks won't last in the LevFin space - just look at CS disappearing, Deutsche Bank significantly pulling bank, Barclays recent move to scale down its investment bank, and so on. There will be deals where banks don't have the appetite to underwrite, or at unattractive terms, or situations where having a couple DL shops provide quick and guaranteed financing is simply easier.
I also agree with some of the other comments that DL will consolidate. I even think DL will get to the point where large DL players or even investment banks will start syndicating DL deals - there are some recent DL financed transactions with easily >20 DL funds involved, that awfully starts to look like your typical syndicated leveraged loan deal. In addition to syndication, I also expect to see a more pronounced secondary market appearing; there already is a secondary market with DL exposure being traded, although this currently is relatively small.
Bottom line: I think being in DL/private credit is a great spot to be in today with many good things yet to come.
As for syndication, this has been happening for years its not new within PC.
As for an active secondary market, at that point its basically public credit and the PC firms won't be able to justify their enhanced fees over traditional BSL managers. Additionally, it will be a rug pull on the bs marks that PC markets to LPs by not having to MtM. Can this happen, I suppose. However, be careful what you wish for as the fee compression will be massive. Then again, the fee compression is likely on the horizon as the asset class grows.
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