When 2024 began, there were widespread expectations that interest rates would decline this year. However, interest rates have not declined as much as originally anticipated, and are still considered relatively high in a historical context. This is poised to change in the coming months, as recent indicators suggest a deceleration in the labor market, providing the window for the Federal Reserve to lower interest rates. 

We believe Private Credit will continue to be an attractive asset class for two main reasons: even with rate cuts from the Federal Reserve, interest rates should stay higher than recent norms, ensuring ongoing income for investors. Additionally, these cuts should ease financial pressures on borrowers, providing support for continued low default rates. Moreover, private credit default rates in the U.S., an indicator of financial pressure, remain modest despite elevated interest rates

Moreover, private credit default rates in the U.S., an indicator of financial pressure, remain modest despite elevated interest rates. Historically, private credit has typically exhibited a low credit loss rate.⁴ Over the last 10 years, for example, private credit had a loss rate of less than 1%, well below that of high yield (Figure 1). More recently, the trailing 12-month private credit default rate by issuer count (through March 20, 2024) stands at 2%, or 1.5% and 3.5% for sponsor-owned (in other words, owned by a private equity firm) and non-sponsor-owned borrowers (those not owned by a private equity firm), respectively.⁵ 

At the same time, demand remains robust for private credit as the flow of funding for deals continues to be strong. According to KBRA Analytics, which tracks direct lending deals, the first quarter of 2024 saw $49.3 billion in U.S. direct lending volume, a 155% increase from the $19.4 billion tracked a year ago. Despite the mixed signals present today stemming from a bifurcated U.S. economy, the better part of the first half of the year provided a moment of clarity around the economy which helped deal flow return to normal. 

We believe this could portend the potential for a bigger bump in the second half, unless current mixed signals evolve into bigger shocks. In addition, non-listed business development companies’ (BDC) sales increased by 11.5% in the first three months of 2024 from the prior three-month period, according to Stanger Research.⁶ 

Meanwhile, on the supply side, LBO⁷ debt financing continues to face a significant funding gap at a time when private equity funds continue to hold record-high levels of capital available for such deals; what is often referred to as “dry powder” (Figure 2). As a result, the demand for debt financing has risen meaningfully. The amount of debt funding needed to support the current level of private equity dry powder is estimated to be roughly $2.9 trillion, assuming a debt-to-equity financing ratio of 1.3x.⁸ 

The bottom line: The following factors: relatively low defaults and rising demand, particularly for LBO financing suggest a positive outlook for the private credit markets for the near to medium term.

Read the Alts Quarterly, where we discuss the infrastructure outlook and themes affecting other key alternative asset classes.

ENDNOTES 

¹ Green Street, Q1 2024.
² Pitchbook, Q2 2024. 
³ Cliffwater, Bloomberg.  
⁴ The credit loss rate is generally the percentage loss incurred per $100 lent out.
⁵ KBRA Direct Lending Deals Default Report, as of March 22, 2024.
⁶ The Stanger Report, Stanger Research, March 31, 2024.
⁷ An acquisition of a portfolio company utilizing high levels of debt. Leverage levels can be as high as 90%, with the remainder funded by equity. In an LBO, assets of the portfolio company are often used as debt collateral to support the acquisition.
⁸ Preqin, as of December 31, 2023.

Full disclosures in linked PDF.