Speaker 1 00:00:10 Welcome to the Lending Lowdown. I'm Iana Barza, head of market analysis. I'm joined by CJ Doherty, director of Market Analysis. We're excited to host our third podcast. Our focus, this episode is on private credit, which has drastically altered the lending landscape.
Speaker 2 00:00:28 You're not kidding, IANA. Private credit is very popular these days. In this episode, we wanna give you the low down what it is and why it's revolutionizing the lending space.
Speaker 1 00:00:37 That's a tall order, cj, but private credit referring to debt largely held by non-bank lenders, changed the breadth and depth of capital providers and brought in a lot of new investors from various pockets across asset classes,
Speaker 2 00:00:52 Right? Aana, and it's a market that's roughly, you know, 1.3 trillion in size, and it's growing. That makes it roughly the same size as the CLO market. That's collateralized loan obligations. Who are the biggest buyers of syndicated leverage loans? Um, and, and just to quantify it a bit more, one of the more transparent vehicles in the private credit or direct lending space in the US is business development companies, or BDCs, as we call them. And these particular funds have over 250 billion of assets and growth in the BDC market has surged recently, you know, with assets on our management, nearly doubling in size in the last two and a half years. You know, and, and just to add some more stats, there are over 300 direct lenders, and notably the top 50 or so platforms in the space control over half the a u m.
Speaker 1 00:01:38 It's kind of hard to get, you know, wrap my head around that. And it, and it's hard to believe just how quickly this all came about. So in the early two thousands, bankers with long track records of lending to smaller companies started their own shops. They provided much needed support via financings during that economic downturn. And it paid off many of their portfolio companies not only performed well, but they grew rapidly in that recovery. And of course, the support of the track record of these new non-bank lenders. And back then we actually called them specialty finance lenders,
Speaker 2 00:02:14 Right? And, and when the great financial crisis took its toll on the banks, and as we know, new regulations came out to, to prevent, prevent it happening again, uh, there was vulgar, um, et cetera. But specifically I'm referring to leverage lending guidance, uh, and which, you know, placed some restrictions on bank lending activity. And this in turn created opportunity for non-bank to step in as they were unregulated and, uh, not subject to the same rules.
Speaker 1 00:02:40 And, you know, as those opportunities grew, so did their funding sources. So initially back in the early 2000, these specialty finance companies, they were relying on pretty limited sources of funding. That's how they got started, like just issuing a balance sheet, coo. So I remember, you know, going on tour speaking to sold out rooms of investors in London and Dublin and New York, and explaining how these vehicles worked and what were these middle market loans that they were investing in. And, you know, needless to say, they gained traction very quickly.
Speaker 2 00:03:13 Yeah, they sure did. And, and after the great financial crisis, these shops attracted more capital from investors like insurance companies, pension funds, and sovereign wealth funds. They also formed strategic partnerships, alliances, sidecars, joint ventures, in essence, diversifying their funding platforms.
Speaker 1 00:03:30 I mean, it was, it was quite a steep learning curve, um, you know, for investors. And, and then of course, private equity also got in the game. So they leveraged off of their fundraising capabilities. They set up their own direct lending funds. And, and this was alongside the capital markets groups that they'd also set up. And we essentially saw the institutionalization of private credit. Yeah,
Speaker 2 00:03:52 We sure did. And, and as the investor base diversified, so did capital structures, you know, further attracting investors interested in higher yields to get in the game. You know, if we look back in the early two thousands, these lenders began offering a one-stop shop for the first time, as it was called back then. So you could get your junior senior execution, um, get access to more junior debt, like second liens. So effectively borrowers started to get a, a whole menu to pick from
Speaker 1 00:04:19 In this menu. Um, you know, it ranged from mezzanine. So there were funds devoted solely to mezzanine, senior stretch, first lien second lean. This menu got bigger and bigger for these smaller middle market issuers, but then it start to expand and they start to serve larger issuers offering now some of the biggest deals we see in the market.
Speaker 2 00:04:40 Yeah. And, and look at the rise of jumbo unit tranches, you know, unit tranches were the evolution of the, the one-stop shop giving issuers the whole cap stack in one loan. And, and they've grown dramatically in size. You know, in fact, you know, in 2019, we saw three deals over 1 billion in size. More recently we saw, uh, 19 unit tranches in the, in the first half of this year alone, which were over 1 billion.
Speaker 1 00:05:05 I mean, it was such a big deal when we saw that first union over 1 billion, you know, everybody sort of scratched their heads like, how, you know, how much growth are we gonna see here? And what enabled this growth? And that really goes back to the fundraising efforts because that led to a diversification in the investor base. And if you think about it, when you manage a growing array of institutional accounts, now that allows you to distribute risk, it allows you to take on bigger commitments. So hold sizes for these deals climb dramatically, and they really do still remain a differentiating factor.
Speaker 2 00:05:39 Yeah. Even this year, you know, which has been marked by volatility in the, in the credit and equity markets, we still attract a hefty 90 billion in private credit fundraising at, and this was targeting the middle market, and it was in the first half of the year. So, so a lot of money,
Speaker 1 00:05:54 I mean, this provides borrowers, right, with so much more optionality. So again, going back to the start in 2000 when these one-stop shops emerged and they offered you the financing you desperately needed in an uncertain time, but actually it really also quickly became a mainstay throughout the cycles, albeit at a premium. And that premium for a borrower, it offered you certainty and speed of execution limited or maybe no price flex higher leverage, more flexibility in your capital structure. That menu we talked about and no ratings process.
Speaker 2 00:06:28 Yeah, the premium also meant, you know, a higher yield, uh, for investors, which proved to be particularly attractive in the, the low interest rate environment that we've seen most of the time since the credit crisis. You know, yields and loans have been enticing relative to other asset classes, and it's attracted in investor money. And, uh, you know, as we've noted, we've seen a huge amount of money flow into the asset class. Um, and, and moreover, you know, given appetite for higher yield, direct lending funds are often structured to lend further down the cap stack than banks. Uh, for, for example, they've been doing, you know, uh, the second liens, even if the broadly syndicated lenders were doing the other portion. And, and of course it does vary between and across different types of private debt fund. You know, looking at BDCs again, just as an example, they've shifted in recent years to a larger share of first liens.
Speaker 1 00:07:18 You know, you gotta keep an eye on the space because it is so dynamic. These shifts are, are constantly happening and it's also really competitive as you can see. Um, it's attractive to investors, attractive to lenders, but direct lender fees and fund fees have been under pressure because of that, because it is a really competitive environment. And we've also seen funding sources continue to shift. So they've been broadening across geographies and also here in the US now, the retail and the wealth management channels have been tapped. Now, CJ BDCs, they always had a retail element. Yeah,
Speaker 2 00:07:54 Yeah, they certainly have aana. And you know, what's really interesting when it comes to, to tapping retail investors is that in the last 18 months, we've seen the introduction of Perpetual Life BDCs. Uh, and these funds are structured a little differently. Um, they, they continually offer new shares monthly, but they also offer to redeem 5% of shares every quarter. So they offer investors some liquidity. So, you know, I would say more liquidity than the average private debt fund, but not as liquid as a public bdc. And they've grown a lot, you know, in aggregate they have, you know, 74 billion, 75 billion in a u m as of June and impressively that's up from only 12 billion a year earlier. So it shows tremendous, you know, appetite from retail investors, including the high net worth variety.
Speaker 1 00:08:40 You know, CJ you touched on liquidity and that's something, um, you know, it's something to really think about. These investors do have to think about these rather, you know, less liquid assets. Um, and I also wanna say that, and maybe it goes without saying that direct lenders have also had challenges, right? As has every asset class with Covid, with the volatility we've been through recently, deals stalled. And there was a lot of caution on lenders parts. Now lenders kept the doors open, and that's kind of what what we anticipated and what we saw. And we've come through some of that, but not without difficulties. And if we look ahead, we're facing a lot of uncertainty. So how will portfolio companies perform? We're in an inflationary environment. There's a lot of headwinds, supply chain labor issues. It is not clear sailing ahead for these issuers. And what's also fascinating to me about this is the way banks have navigated and participated in this space. But I think that is for another day.
Speaker 2 00:09:39 In these last 10 minutes, we've tried to touch on something that's been evolving for over 20 years. We've barely scratched the surface. So for more on this topic, check out our reports and
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