Private Credit Outlook: Better Returns Amid Reduced Risk
Earlier this Spring, we wrote two articles about the tailwinds providing extremely attractive risk-adjusted returns in the private credit markets, especially direct lending. Since then, the financial environment has only improved for private credit lenders, and large financial institutions are now beginning to wholeheartedly recommend the strategy.
Christian Salomone
Chief Investment Officer
christian.salomone@ballastrockpw.com
Just this month, JP Morgan’s investment team stated that, “private credit is one of our high-conviction investment ideas, especially the sub-strategy direct lending,” while Goldman Sachs’ Asset Management team wrote that “In a higher-for-longer rate environment, we see opportunities for investors to earn equity-like returns in private credit.” Across the industry, money managers are seeing record inflows into private credit funds, as accredited investors gravitate towards an asset class that is having its “Golden Moment,” according to asset manager Blackstone. It is not hard to see why. Year to date, the average direct loan is yielding roughly 12.5%, significantly more than public market alternatives that are inherently riskier.
As we described earlier this year, direct lending is a well-established option within the private credit market, catering primarily to small or medium-sized businesses in the lower middle market. These companies frequently turn to direct lending for financing acquisitions, capital expenditures, working capital, and various other financial requirements, making it a key player in today's financial landscape. Borrowers obtain loans directly from institutional investors or specialized lenders, sidestepping traditional banks.
One reason for this growth is that small to medium regional banks have still not recovered from the banking crisis back in March. Their balance sheets remain in disarray and pending regulatory changes are expected to require all banks to keep more cash on their balance sheets, reducing the capital that they will be able to lend to growing companies. This dynamic continues to create opportunities for private credit funds to step in and replace the capital traditionally provided by banks. For this reason, we have seen lending specialists migrate from banks to private credit funds, further strengthening the sector’s underwriting expertise.
The loans written by direct lenders are typically senior in the capital structure, come with floating rate coupons, are safeguarded by assets and recurring revenue streams, and include repayment priority over other creditors. Direct lending platforms offer agility in underwriting processes, boasting customized structures, and repayment schedules to align with borrowers' specific needs. Companies pay for these flexible terms and speed of execution in the form of higher interest rates and more restrictive terms and conditions (aka covenants), which offer protection for the lenders. What makes this market so attractive at this time is that even as yields have risen, risk, as measured by Debt to EBITDA ratios, has gone down over the past 12 months. That means much better risk-adjusted returns for accredited investors. Most asset managers expect these returns to last for the next 18- to 24-months. Sticky inflation has led to the continued rise in interest rates, taking yields available to investors to their highest levels in decades. In August at Jackson Hole, Fed Chairman Jerome Powell made it clear that interest rates could continue to rise and stay higher for longer, further adding to the attractiveness of direct lending. As a result, we remain very constructive on private credit, and we remain pleased that others in the financial markets are catching up to our way of thinking. Please reach out to us with any questions or feedback, or to discuss how our approach to wealth management may benefit your own portfolio.
Disclosure: Past performance is not indicative of future results. The opinions expressed are those of Ballast Rock Private Wealth and should not be taken as financial advice or a recommendation to buy or sell any security. BRPW is a registered investment adviser. Registration does not imply a certain level of skill or training. Any forecasts, figures, opinions or investment techniques and strategies described are intended for informational purposes only. Past performance is not indicative of future results. Investing involves the risk of loss of principal. Investors should ensure that they obtain all current available information before making any investment. Indices cited in the information above are intended to support the opinions expressed and are shown as general examples of market trends. It is not possible to invest directly in an index and the volatility of the index may vary from that of an investor’s actual account. Note that index performance shown does not take into account management fees and is not intended to be indicative of future results. Additional information about our investment strategies, risks, fees, and objectives can be found in BRPW’s Form ADV Part 2. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions. There is no guarantee of the future performance of any Ballast Rock Private Wealth portfolio. Material presented has been derived from sources considered to be reliable. but the accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation, recommendation, or an offer to buy. sell or hold any securities, other investments or to adopt any investment strategy or strategies.
