Private Credit Is Hot. But Has It Gone Silly?

Private credit is an asset class that has blossomed alongside the Federal Reserve’s rate hikes. From sovereign funds to family offices, many people want to put their money in. Asset managers are more than happy to latch onto this enthusiasm. Private-equity firms are racing to raise funds, hoping to diversify from their long-time cash-cow buyout business, which has grown a bit tired with the end of the zero-rate era. The likes of BlackRock Inc. are also beefing up operations, buying up private-debt specialists.

The lure of private credit is obvious. Borrowing costs are staying higher for longer. Loan demand is there because banks are pulling back. The US economy appears to be heading into a soft landing, not a recession. Plus, these lenders have the regulatory green light — they’re seen as useful shock absorbers, not troublemakers who can pose systemic risks. By now, private credit is a $1.5 trillion asset class, bigger than high-yield corporate bonds or leveraged loans.

But here is the worry: With so much investor interest, will fund managers start to lower their lending standards just to close deals, put money to work and move on to raise even bigger funds? After all, earning management fees has become as important a profit driver as getting a chunk of investment-capital gains. Private-equity giant Blackstone Inc., whose assets under management crossed the $1 trillion mark in the second quarter, collected $4.4 billion in fee-related earnings over the last year alone.

It’s a tough question. We don’t get to see the lending documents — they are, by definition, private. We thus do not know if private debt has started going covenant-lite, just as the US leveraged-loan market became with the rising appetite of collateralized loan obligation investors. According to S&P Global, as of 2021, over 90% of the covenant-lite loans were bought by CLOs.

But there is some reason to believe that private credit hasn’t gone silly yet.

In the second quarter, private-debt funds raised $71.2 billion, a strong rebound after two quarters of hiatus, data from industry research provider Preqin shows. However, it was a winner-take-all, with more experienced managers raising bigger funds. For instance, HPS Investment Partners, which spun out of JPMorgan Asset Management in 2016, closed a $17 billion junior credit fund, in addition to a $10 billion one focusing on senior secured loans. It is one of the few direct lenders that can single-handedly underwrite billion-dollar loans.