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You probably recognise the headlines even if you don’t follow finance: “This opaque $1.5tn market is conquering the lending world”, things of that nature.
Those headlines are about the private-credit market, which is indeed growing at a fast clip. But it isn’t nearly as large as traditional markets for junk-rated debt, despite ostensibly similar numbers, Barclays says in a Wednesday note. (Fitch Ratings put the US’s high-yield bond and loan markets at $1.3tn and $1.7tn, respectively, at the end of 2022.)
The confusion comes from a nuance in data from firms that track private capital, like Preqin. The $1.5tn figure includes dry powder, or money that’s committed to private credit that hasn’t been allocated or invested yet. There is a solid reason for its inclusion, to be fair; Preqin’s services are generally meant for money managers (and sales teams), so money allocated to a market matters almost as much as money that’s deployed in that market.
Still, that means the flashy headlines are comparing apples and oranges. If half of a high-yield bond fund is held in cash, it wouldn’t make sense to count all of its assets toward the size of the high-yield bond market. So the relevant figure for the global private-credit market is $1.1tn.
And remember, these private credit figures are compared only to US junk-rated credit markets. So really the best comparison is $675bn — about half the size of US markets. From Barclays:
Now, the amount of uninvested dry powder is significant, and that is meaningful for the broader credit market, Barclays points out — it just doesn’t make for a helpful size comparison with high-yield and leveraged loan markets. If private credit managers rushed to deploy cash, they could add froth to credit markets and lead to lower debt-contract quality across the board:
There are plenty of recent instances when this has occurred. There is strong correlation between the growth of CLO assets and [lower loan-contract quality]. In addition, as dry powder accumulated, pricing on private credit deals declined substantially relative to broadly syndicated loans as a way to compete for lending to bigger – and to be fair, often better – companies.
Even so, the bank says the post-financial-crisis years could be a helpful comparison. Market watchers expected a wave of cash from private equity to support valuations. To put it mildly, that did not happen:
Barclays also does some mythbusting about the opacity of the private-credit market. Private credit markets are highly illiquid, but that doesn’t necessarily mean they’re fully opaque. (It just means price discovery is slow, which can be a selling point for institutional investors who aren’t eager to quickly mark down values of investments.)
In fact, most business development companies or BDCs report results quarterly. This holds true even for BDCs that aren’t traded, where investors can only withdraw cash through a quarterly tender offer.
While BDCs’ $300bn in assets are just a fraction of the market — Barclays puts them at 40 per cent of the US market — they still provide a window:
Given all of this, how much can we really say that private credit is taking over the lending landscape?
The popular argument is that companies that could be financing themselves in leveraged loan and high-yield bond markets are instead going to private lenders for better lending terms and, uh, privacy.
Some borrowers have probably been drawn to private markets. Barclays points out that the combined size of the junk-rated loan and bond markets fell for the first time since 2016 last year, while private credit markets kept growing.
But the typical private-credit borrower is still much smaller than the loan or bond issuer. And the bank estimates that only around $150bn (maybe $180bn max) has been “cannibalised” from high-yield loan and bond markets:
It is difficult to say with certainty what percent of the high yield/leveraged loan markets has been cannibalised by private credit. We estimate that since 2019, when private credit growth accelerated materially and HY/LL growth lost steam, the upper bound could be around $180bn. However, the true number is likely to be at most $150bn when we consider deals that never could have made it to the HY/LL markets traditionally, as well as the nuances of high-yield bond indices.
Another important caveat is that all of the shrinkage in junk-rated debt came from markets for fixed-rate bonds, in a year when US interest rates rose by four percentage points, the fastest pace in decades. The investment-grade bond market’s growth has (unsurprisingly) slowed as well in those conditions.
So it’s probably worth attributing the shift not to private-credit cannibals, but to the Federal Reserve and simple bond maths.
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