Stockholm (HedgeNordic) – The evolution of private credit as an asset class has been remarkable, attracting increasing allocations from investors. Assets under management by private credit funds have surged from just over $310 billion at the end of 2010 to $1.52 trillion today, with projections indicating a rise to $2.8 trillion by the end of 2028. However, the record-high assets under management and dry powder levels, particularly among the larger managers, have raised concerns about an oversupply of capital chasing a limited opportunity set.
“As banks steadily recede from the loan market, private credit funds have proliferated both in number and scale to cater for unmet borrowing demand,” explains Rodrigo Trelles, co-head alongside Baxter Wasson of O’Connor Capital Solutions, a distinct investment unit within UBS Asset Management focused on private credit. “However, amid the deluge of capital flooding into private credit, some investors are scrutinizing whether key supply-demand dynamics are sustainable,” notes Trelles, especially in the upper segment of middle-market lending.
“However, amid the deluge of capital flooding into private credit, some investors are scrutinizing whether key supply-demand dynamics are sustainable.”
Rodrigo Trelles, co-head of O’Connor Capital Solutions
According to Trelles and Wasson, the upper segment of middle-market lending has evolved into a distinct asset class dominated by a select, yet expanding, group of large private managers. These managers primarily focus on underwriting large loans ranging from $500 million to over $2 billion for substantial enterprises typically owned by prominent private equity sponsors. Wasson highlights “that fundraising within this segment has accounted for a significant portion of the recent capital raised in private credit,” as evidenced by Preqin data showing private debt investors allocating capital to a small number of larger funds.
Of course, the concern regarding the record-high dry powder levels is that the pressure to deploy capital may result in a deterioration in pricing and non-pricing terms, such as lower underwriting standards and weakened covenants.
Opportunities and Challenges
While much attention has been on upper-middle-market direct lending, Trelles and Wasson suggest that “lesser-known sub-strategies and segments warrant consideration as a more lender-favorable supply and demand mismatch persists in these parts of the market.” These strategies include non-sponsor-backed lending, asset-backed lending, mezzanine lending, special situations, hybrid opportunities, and distressed investing.
“Lesser-known sub-strategies and segments warrant consideration as a more lender-favorable supply and demand mismatch persists in these parts of the market.”
In the past, regional and mid-size banks were responsible for lending to the non-sponsor-backed market. “However, their capacity to serve these segments has diminished due to regulatory constraints and internal strains,” as noted by Trelles. The Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices released in early February underscores this trend, with respondents reporting “tighter standards and weaker demand for commercial and industrial loans to firms of all sizes over the fourth quarter.” The latest survey from April indicates the same trend.
Rodrigo Trelles and Baxter Wasson highlight the complexities of sourcing opportunities in the non-sponsor-backed segment of the market, noting that many potential borrowers that own or operate middle-market businesses lack “capital markets” desks. This ecosystem typically generates deal flow characterized by smaller, relatively complicated loans of between $25 million to $250 million that require disciplined underwriting and structuring tailored to specific company or asset financing needs, argues Wasson. “This presents a significant opportunity,” he emphasizes, as small to mid-sized US companies significantly outnumber their large sponsor-owned counterparts, creating persistent need for capital amid limited non-bank or private credit lender supply.
At the same time, investors can diversify their private credit portfolios by incorporating exposure to such segments. “Returns are typically uncorrelated with other credit holdings and exhibit diminished sensitivity to interest rate fluctuations,” argues Trelles. However, delivering this “requires access to proprietary and well-established sourcing networks capable of facilitating steady deal inquiries across diverse borrower profiles, loan structures, and collateral types,” he explains. This is where affiliation with a global bank and wealth manager can be advantageous, he adds. “The handful of managers that can offer this may be able to exploit the scarcity premium on offer by providing tailored borrowing solutions in markets with limited lending competition.”
“Many borrowers clearly value the expediency, certainty, and direct engagement facilitated by private credit lenders, which often leads to a superior borrowing experience compared to traditional banks or public markets.”
Baxter Wasson, co-head of O’Connor Capital Solutions
Trelles and Wasson believe that the systemic shift away from banks is likely to continue. “Many borrowers clearly value the expediency, certainty, and direct engagement facilitated by private credit lenders, which often leads to a superior borrowing experience compared to traditional banks or public markets,” concludes Baxter Wasson. This trend may explain why borrowers who historically relied on leveraged loans, high-yield bond markets or regional and mid-size banks have increasingly gravitated towards private credit in recent years.
