Capital Raising in Private Credit: Market Growth, Opportunities, and Insights

Posted by | Nilesh Sharma

The rise and rise of private credit

In recent years there has been a significant rise in private credit, with providers encroaching on traditional banking by offering capital to business owners and other borrowers. According to data and research firm, Prequin, the global market grew from a relatively small US$41 billion in 2000  to US$1.7 trillion by the end of 2023. This market is expected to exceed US$2.8 trillion by the end of 2028, making it one of the fastest-growing alternative sources of capital in the global financial system.

The majority of this growth has occurred in North America, with the US accounting for over two-thirds of the global market. Private credit providers have begun to fill the gap left by the banking sector’s reduced lending capacity, which resulted from higher interest rates and the US Federal Reserve’s monetary policy tightening, especially after the spate of bank failures in 2023. These conditions have also enabled private credit funds to provide essential capital to small businesses and ventures.

What constitutes private credit?

The term ‘private credit’ is used broadly and can refer to consumer loans, corporate loans and even commercial mortgages. Capital raised from private credit providers is particularly useful for small and mid-sized businesses with limited or below ‘investment grade’ creditworthiness, as lending terms are more flexible than those of typical bank loans. In addition, many of these providers specialize in specific areas such as lending to agriculture, agri-business or small and medium-sized enterprises (SMEs), making this alternative source of capital attractive to borrowers seeking capital raising services.

For simplification, private credit can be categorized into the following:

• Direct lending or senior credit
• Mezzanine or junior credit
• Distressed credit
• Special situations credit

What makes private credit so attractive?

One of the key reasons for the unprecedented growth in recent years has been the potential for higher returns, especially when compared with returns for bonds and dividend income through equity contributions. Data from Prequin indicates that the aggregate private credit index has outperformed its historical returns, especially since the beginning of 2022, and is now higher than returns from private equity investments, making it a compelling option for those involved in private equity fund raising.

This growth has prompted other senior and more established market players to venture into the space, with Wall Street behemoths such as Goldman Sachs and JP Morgan Chase creating dedicated private credit trading teams in anticipation of a more active secondary market. Other examples of savvy investors include the Man Group, a large hedge fund, which recently acquired a controlling stake in Varagon Capital Partners, a US$12 billion credit fund. This trend underscores its attractiveness as an avenue for raising funds for business ventures.

Challenges abound

This growth has attracted significant criticism. Traditional banks argue that increased lending from alternate capital providers allows risks to go unmonitored since many of these players operate outside the regulated banking system. This situation also gives players in the market an ‘unfair’ advantage, as they are not subject to the stringent capital requirements that traditional banks must adhere to.

However, proponents of private credit  argue that shifting to long-term capital, which takes on associated credit risks, is making the banking system less leveraged and more resilient. In addition, most private credit funds raise money from long-term institutional investors, such as insurance companies and pension funds, who are willing to provide locked-up capital and do not expect immediate short-term returns. This demonstrates how it can be a crucial tool in fundraising and raising capital for business activities.

Regulation

With the private credit market set to reach US$2 trillion in 2024, there are increasing calls from both market players and policymakers for greater scrutiny of these funds. Unchecked growth could create additional ‘systemic’ risk for the financial system, prompting the Financial Stability Oversight Council to propose a new framework that would bring firms operating in this market under the oversight of the US Federal Reserve.

Tags: private equity