With Reduced Bank Lending and Lack of Liquidity, the Stage is Set for Private Credit
Last month, we highlighted how the interest rate environment and disruptions in the banking sector indicated that direct lending platforms are stepping into the void left by traditional banks as they deleverage their balance sheets and reduce their loan portfolios. As a result, we expect private credit funds to provide a solid source of income and deliver outsized risk-adjusted returns for their investors.
Christian Salomone
Chief Investment Officer
christian.salomone@ballastrockpw.com
These trends have only accelerated since our initial thinking, and we see more signs that current events are creating one of the best markets for private credit in years.
Many investors are beginning to act on this trend and take advantage of private credit opportunities. In its 2023 Family Office Investment Insight Report, Goldman Sachs noted that, while private credit is a rather small part of family-office portfolios at 3%, 30% of respondents reported that they expect to increase their allocation to private credit over the next 12 months.
Why such interest by ultra-high-net-worth families? In addition to the floating rate nature of private credit, which is an advantage in the current environment, Goldman Sachs said family offices also value private credit’s potential to provide seniority in the capital structure, stable cash flows during uncertain economic conditions, and incremental yield to the portfolio.
Institutional investors have long seen the benefits of private credit (and private-market investments in general) and are equally taking advantage of the opportunities. Recently, New Jersey’s pension funds became the latest to recognize the benefits of private credit and are rebalancing their portfolios to take advantage of stable direct lending strategies.
Of course, amid this interest are also some investor concerns. With the extraordinary growth of private credit funds, which are unregulated, there are questions being raised, particularly in the media, that these trends could lead to systemic risks or create a dangerous “shadow” banking system.
“At Ballast Rock Private Wealth, we firmly believe that...investing in private markets demands active management.”
It is true that all investments carry risks, but we do not see signs of systemic risk in private credit. Though private credit has grown six-fold over the past decade, it is still only a tiny segment of the overall credit market. Nevertheless, the growth necessitates strict due diligence in order to choose the right investment managers. At Ballast Rock Private Wealth, we firmly believe that this highlights the other argument I made last month, that investing in private markets demands active management. As the size of the private credit market increases, and the need for capital becomes more acute, it is crucial for investors to identify top quartile managers who can execute on the strategies with the best risk adjusted returns.
We continue to believe that senior direct lending currently offers one of the best opportunities in the market. Direct lending yields are similar to riskier credit strategies, while the majority of the direct lending loans are the senior-most debt in a private company’s capital structure. Therefore, investors have a first- or second-lien claim on the assets that were used as the loan’s collateral, meaning that even if defaults rise, investors at the top of the capital structure are better protected and will experience less volatility.
However, it is crucial to invest with managers with strict underwriting criteria, low historical loss rates, strong track records, and deal flow that allows them to lend to the strongest companies at the best terms.
We continue to believe that senior direct lending currently offers one of the best opportunities in the market. Direct lending yields are similar to riskier credit strategies, while the majority of the direct lending loans are the senior-most debt in a private company’s capital structure. Therefore, investors have a first- or second-lien claim on the assets that were used as the loan’s collateral, meaning that even if defaults rise, investors at the top of the capital structure are better protected and will experience less volatility.
However, it is crucial to invest with managers with strict underwriting criteria, low historical loss rates, strong track records, and deal flow that allows them to lend to the strongest companies at the best terms.
In conclusion, the continued market conversation around private credit underscores the compelling opportunity for investors seeking attractive returns and diversification. With reduced bank lending and a lack of liquidity, the stage is set for private credit to thrive.
As private credit continues to evolve, investors who understand the risks and rewards of this asset class will be well-positioned to benefit from the tail winds driving this dynamic market.
Have questions? Contact your financial advisor or our team members at Ballast Rock Private Wealth at ir@ballastrockpw.com.
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.
