It’s a Lender’s Market in Private Credit

Higher yields, increased negotiating power, and favorable business cycle conditions have made private credit the most attractive alternative investment, according to BCA Research.

Illustration by II

Illustration by II

At BCA Research — which recently established a research unit focused on private markets and alternatives — private credit has emerged as the asset class to watch.

“Overall, interest rates have gone up, yields are higher, and expected returns are much higher,” said Bryan Payne, chief strategist for private markets and alternatives at BCA, a sister company of Institutional Investor. The new unit, which was launched by the company last week, offers investment advice across private equity, private credit, hedge funds, and real estate.

“Yields are now in the double-digit arena,” Payne said. Until recently, private credit investors were only getting paid an average of 5 percent to 8 percent. “Rates were so low, [and that] helped support price appreciation across growth assets, particularly private equity, venture capital, and real estate,” he added.

As interest rates have risen and credit has become harder to access, private credit lenders have gained more bargaining power over borrowers. That means that private credit managers can tailor deals that work to their advantage. For example, private credit managers can include convertibles or warrants in their contracts, which provide an option to transform debt into equity or purchase equity at a discount, once borrowers reach a predetermined growth milestone.

“Now that banks are stepping away, lending standards are becoming tighter,” Payne said. “And these long-duration assets, particularly private equity, need that capital to get to that stage of growth. The negotiating leverage is with the creditors.”

The current business cycle also favors private credit over other alternative asset classes, especially private equity, Payne added. From a historical perspective, when credit is as tight as it is in the current cycle, “private credit outperforms private equity over the next five to seven years,” he said. Private credit subsectors such as distressed and special situations, which focus on financially troubled companies, are especially well positioned in a recessionary environment, he added.

“We’re really not in that type of growth environment anymore,” Payne said. “We’re in a lending environment, and now you’re getting paid really well to do it.”