As investors increasingly allocate capital across the private debt markets, evolving macro and financial conditions may necessitate a need for greater transparency.
Private credit has long been an important source of funding for small and middle-market borrowers, alongside the broadly syndicated loan and speculative-grade bond markets. But it wasn’t until recently that the private credit market has seen such explosive growth. This decade-long expansion (against the backdrop of rising credit pressures) has put the focus on the burgeoning risks in an opaque market.
The risk factors associated with private credit are the same as those for mainstream credit—but the emphasis will differ depending on where a borrower is in its life cycle, as well as broader credit conditions. As signs of credit stress emerge and defaults creep up, it remains to be seen whether this “golden age of private credit” can continue.
At S&P Global Ratings, our independent opinions on creditworthiness take a holistic view to provide greater transparency for the totality of private markets participants—from direct lending, business development companies, and middle-market collateralized loan obligations, to private equity, fund financing, and beyond.
WATCH: The Growth of Private Debt Markets
Alternative investment funds (AIFs) are increasingly turning to credit markets through bond issuance, net asset value facilities, capital call facilities, and subscription lines to diversify and optimize funding, as well as focus on credit investment strategies including private loans.
While uneven liquidity and strained valuations have buoyed this latest burgeoning activity, S&P Global Ratings has provided transparency on this expanding market since 2006—and our coverage and criteria have evolved.
We apply our global framework for rating AIFs (updated most recently in 2021) to various funds whose investment strategies span private and public equity, venture capital, and private debt, as well as hedge funds and other investment companies that share key characteristics of AIFs.
Facing rapid shifts in financing conditions, including a downturn in syndicated loan issuance in the last two years and this year's rebound, leveraged borrowers are turning to private, as well as public, sources for funding.
We sampled about two dozen borrowers that turned from public credit to private and found that access to funding was key for some, as about a third were rated 'CCC+' or lower.
However, for those issuers rated 'B-' or higher before turning to private funding, we expect that the flexibility of terms and the certainty of execution in private credit were likely motivating factors.
With loan volumes rebounding this year--and spreads narrowing--we've seen some take back by the syndicated loan markets from private.
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Total assets of business development companies (BDCs) and interval funds rose by near 12% over the past year to $325 billion in third-quarter 2023, and this growth is supporting the availability of funding for private credit borrowers. Nontraded BDCs have led the recent growth, with total assets of nontraded BDCs nearly tripling over the past two years. While private credit borrowers have shown progress reducing near-term maturities over the last year, these recent refinancings are adding to the maturities coming due in 2028. The average yield on a private credit loan fell somewhat in the third quarter of 2023, down 48 basis points (bps) to 10.3% as investors began to look ahead to eventual rate cuts.
The diversity of borrowers, backed by a broad mix of sponsors, may help diminish concentration risk of assets that business development companies (BDCs) hold in their portfolios. Private equity sponsors back nearly two-thirds of the borrowers whose loans are held by BDCs, and sponsor-backed borrowers account for a larger share of direct lending assets than broadly syndicated loans. While there is diversity among sponsors, the largest are more highly exposed--the most active 10% are involved with 50% of issuers. For smaller sponsors with only a single deal each, nearly 90% of the borrowers backed by these single-deal sponsors are borrowers with non-broadly syndicated loans.
After robust issuance in 2023, credit estimates picked up even more pace in the first quarter of 2024, with a record 750 credit estimates completed (217 of which were new estimates).
Credit estimate downgrades continued to be driven by the impact of higher debt servicing costs on companies given the steep increase in benchmark rates. We expect downgrades to continue, but the volume will likely begin to moderate given the resilience and sustained growth of the U.S. economy, some stabilization in inflation, clarity for now around the direction of policy rates, and efforts companies have taken to contain costs.
The pace of selective defaults moderated during first-quarter 2024. The bulk of these were due to payment-in-kinds (PIKs)/deferrals, followed by entities extending their loan maturities as exits remain challenged for sponsors.
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Here are some ways our products can help private market participants.
Available for private equity, direct lending/mid-market and feeders, private debt and hedge funds plus real estate, infrastructure, VC funds and rated note structures.
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Learn MoreA confidential indication of the creditworthiness of an unrated company or portfolio of companies in an alternative fund, supported by a credit rationale report.
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