Banks and investors increase bets on private credit boom

IFR 2412 - 04 Dec 2021 - 10 Dec 2021
11 min read
Christopher Whittall

Investment banks, asset managers and hedge funds are beefing up their presence in private credit markets amid widespread expectation that demand for illiquid investments offering higher returns than publicly traded debt will increase rapidly in the coming years.

Global private debt assets under management have more than doubled from just over US$500bn in 2015 to US$1.1trn at the end of March, according to data provider Preqin, comfortably outstripping growth rates in public corporate bond markets over that period. That has come as an increasing number of institutional investors have shifted to less liquid credit exposures to meet return targets in a low interest-rate world.

Alternative investment managers have tended to dominate private debt transactions, with the top 10 firms raising around US$300bn between them in the decade leading up to 2021, according to Preqin. But a broader cross-section of the financial industry is now investing heavily to carve out its place in these burgeoning markets, which have swelled over the past decade amid a decline in traditional bank lending.

“The private credit market is evolving quickly and continues to be a growing area of interest for our client base,” said Rehan Latif, head of credit trading and sales for EMEA and global emerging markets trading at Morgan Stanley. “We expect it to become part of the overall ecosystem of leveraged credit. In the zero-rate environment, any sort of premia that you want to capture is going to come from relative illiquidity.”

Private credit markets encompass a broad set of activities where investors lend to businesses directly. The primary focus tends to be on financing smaller companies that once might have used bank loans, but in its broadest sense private credit can include funding projects such as real estate or infrastructure, as well as lending against assets ranging from trade receivables to aircraft.

Specialist investors such as Ares Management and GSO Partners have been active in private credit for years, allowing them to source higher-yielding exposures than those typically available in public debt markets. The number of potential deals has only increased since the 2008 financial crisis as tougher regulation forced banks to cut back lending. Michael Dennis, co-head of European credit at Ares, said when the firm started its European direct lending strategy in 2007 it would look at 100 to 200 potential investments a year. In the past 12 months, it has looked at over 1,100 transactions.

“Institutional demand for private credit has increased significantly over the last five to 10 years," said Dennis. "Private credit offers good, floating-rate yields at low levels of volatility. Moreover, as an asset class it has demonstrated its resilience over the last 18 months during the Covid pandemic.”

Firms like Ares have no intention of ceding hard-won ground in these markets to banks – or other money managers for that matter (See Box story). But the growing clamour from investors like pension funds and insurance companies for higher returns in the face of persistently low interest rates is undoubtedly prompting a wider range of financial institutions to search for their own niche in private credit to meet these demands.

The top 10 investment banks are on course to make US$400m in revenues from corporate private credit this year, according to data firm Vali Analytics, which projects the revenue pool will expand to US$1bn in 2022.

“Private debt rivals the high-yield bond market in terms of size. But the amount of resources investment banks have deployed to private credit is a fraction of the size of their high-yield franchises,” said Sanjeev Mordani, co-head of global spread product solution sales at Citigroup.

Rapid expansion

Fidelity International is an example of a conventional asset manager that recently established its own private credit business. Earlier this year it hired a private credit team from European lender MeDirect Bank and acquired a minority stake in specialist investment platform Moonfare.

“A number of key investors, key platforms are looking to consolidate and have fewer managers with a broader range of capabilities. We are very keen to have those strategic relationships,” said Andrew McCaffery, Fidelity International's chief investment officer.

“Our clients across institutional and wholesale markets are faced with the question of how to generate a higher level of income given what’s happened across competing financial assets. In private credit, you may be giving up a level of liquidity, but in many cases you’re getting access to very good quality exposures and you’re getting a yield enhancement,” he added.

Hedge funds are also getting in on the act. Christian Adler, a former senior Deutsche Bank trader, co-founded Astra Asset Management in 2012 to focus on structured credit investments such as mortgage-backed securities and collateralised debt obligations. Since 2019, Astra has been investing in private credit and is currently raising a fund dedicated to such exposures.

Astra has financed an electric vehicle company through an asset-backed loan this year and is looking to extend credit to social housing projects and the UK hospitality sector among other deals. Unlevered yields on deals can range from about 5% to nearly 20% depending on the exposure and complexity, the hedge fund said.

“We see a much more attractive pipeline of deals in private debt right now,” said Adler. “Public markets, whether it’s CLOs or RMBS, look quite frothy and there are fewer deals matching our target profile."


On the face of it, investment banks may not have such an obvious role to play in these markets considering private credit originally developed as an alternative to traditional bank lending. But a number of firms believe there are opportunities to be had across originating, trading and financing private credit exposures.

Credit Suisse, which cut back its broader markets unit this year after suffering huge trading losses, has hired two former Goldman Sachs bankers – Charles Holmes and Yacine Bourezak – to make a push in this space. Barclays, Citigroup, HSBC and Morgan Stanley are among the numerous other firms looking to expand too.

“Disintermediation is definitely happening, but the strength of Citi’s network means there is enough business for us to capture,” said Rajiv Amlani, co-head of global spread product solution sales at the bank.

He gave the example of a Citigroup client that had already borrowed from private credit funds. The company was looking to raise more capital and asked the bank to pitch for the deal. “We ran the process and that created strong competitive tension,” said Amlani, who said the deal size increased from US$150m to over US$500m as a result.

One area where banks see significant growth potential is offering investors financing on private credit portfolios given the demand from some clients to leverage returns. By contrast, buying and selling positions in secondary markets isn’t currently common practice in private credit, though some bankers believe that could change.

“This has been one of the most benign credit environments we’ve ever seen with low default rates. Private credit markets have only got bigger and leverage in the system has increased,” said Morgan Stanley’s Latif. “We believe clients will be looking for secondary market liquidity, either if markets turn at some point or if spread compression continues and they want to lock in returns."

Box story – The new credit behemoths

Ares Management raised the greatest amount of capital for direct lending funds in the decade leading up to 2021 at US$37bn, according to Preqin – roughly the same as the next three largest firms combined.

The sheer volume of money being dedicated to private credit is allowing these managers to encroach ever more on investment banks' mainstay activity of underwriting bond and loan sales in leveraged capital markets.

Last year Ares was lead arranger for a £1.88bn financing to UK insurance broker The Ardonagh Group in what it said was the largest unitranche deal ever. In August, funds managed by Ares's European direct lending strategy were the sole lenders of £1bn in debt facilities to environmental and engineering firm RSK Group, which Ares said was the biggest ever private credit-backed sustainability-linked financing.

"As private credit funds have become larger, we’ve started to compete in traditional capital markets in the high-yield and syndicated loan space – an area that has been the domain of investment banks," said Michael Dennis, co-head of European credit at Ares. "We manage funds that give us the scale to be [more] relevant for larger corporates than ever before. Three to five years ago, some of these transactions would only be executed in the capital markets – private markets didn’t have the scale – but that’s changing."

Dennis said there may be more competition for deals in some parts of the broader private credit world, but in direct lending Ares believes incumbent managers like itself have a significant head start.

"It’s a very resource intensive and relationship-driven business," he said, noting Ares has a direct lending team of 75 people across Europe originating opportunities. "The barriers to entry are very high. We’ve got a portfolio of over 150 names in Europe and 40% to 50% of our capital deployment each year is to our existing portfolio companies. If they need capital, we’re often their first port of call.”

When asked about warnings from some quarters over the growth of private credit markets potentially creating systemic risks, Dennis noted his team only closes on about 3% to 4% of the roughly 1,000 deals that they typically review each year. He also said about 90% of their transactions involve covenanted, first-lien assets. "We’re right at the top of the capital structure," Dennis said.

Others have highlighted private credit's strong performance during 2020's turbulent markets. "The corporate private credit asset class stood up incredibly well last year during the pandemic," said Mitali Sohoni, co-head of global cross-asset financing and securitisation at Citigroup. "Asset managers worked with sponsors to provide significant support for companies."