July 25, 2024 - On July 24th, the LSTA 2024 Summer Series tackled the hot topic of private corporate credit. The session, “Private Credit / Direct Lending” was presented by LSTA Board Member Sabrina Rusnak-Carlson of First Eagle Investment Management and Kate Luarasi of Kirkland & Ellis.
The presenters started by explaining what private credit is not. It is not public credit which includes high yield bonds and broadly syndicated loans. Public credit is often extended to larger companies by banks and then syndicated to many lenders. The loans are typically rated, which is often required by those who buy the loans such as CLOs.
Private credit is the opposite of public credit; private credit is relationship lending. It is an asset class of traditionally illiquid debt investments with a range of risk / return profiles. The loans are private and thus are not made or traded in the public markets (like bonds and equities). They can be first lien or second lien loans, and the credit agreements are highly negotiated. The credit agreements typically do include covenants, but the larger loans made to larger companies may be “cov lite”. Direct lending is an asset class within private credit. Going back to 2007/8 the lending would be the mezzanine debt, but now the focus is on senior debt. Private credit is directly originated by an asset manager who is focused on creating a bespoke structure for that transaction with a credit facility that is tailored for that borrower. A great deal of due diligence, therefore, goes into every deal. Flexibility and ease of execution are key features of direct lending which attract borrowers.
Notably, private credit encompasses a range of strategies, including corporate, real estate debt, infrastructure and special opportunities and within each form or strategy, a lender’s exposure / investment can be tailored to fit that particular investor’s risk / return profile.
Private credit flourished in the aftermath of the Global Financial Crisis. It was a chaotic time where private credit grew because capital was so constrained everywhere, and banks were subject to increased regulatory burdens. The recent pandemic was another inflection point for private credit. It became capital efficient during the periods of low rates to finance expansion and acquisition, and it was during these periods that asset managers were able to find compelling returns in private credit.
Since 2015, private equity deal volume exceeded public equity deal volume, and private equity firms became longer-term holders of assets. Private equity assets under management have increased more than 4.5x since 2006 and because of this there has been a large growth in private credit.
Today, private credit is estimated at $1.8 trillion, with some projecting that by the end of 2028 it will reach $2.8 trillion. The democratization of private credit is taking place both in the US and offshore; thus, designing ways to continue to attract retail offshore investors is a focus of asset managers who are adapting structures that should significantly contribute to private credit’s continued growth.
The middle market is where private credit has seen the most growth. The traditional middle market has seen some convergence with broadly syndicated loans. The documents will typically still include a full set of financial covenants, but you may also see cov lite deals too. The defining aspect of private credit is the relationship – the lender and the borrower are always at the table and always talking.
Even credit facilities in excess of $1 billion or larger can be written by private credit lenders who may then club these deals. Historically, private credit funds have largely been offered through private unregistered commingled closed-end funds. Today, there are many more types of funds available. The presenters noted the different types of fund financing, including subscription lines, ABL facilities, and net asset value lines to name only a few.
The presenters provided excellent slides with many diagrams so for those who learn best through visual aids, I encourage you to review the slides. Click here for the slides and the replay.
