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Borrowing Terms Loosen as Direct Lending Competition Rises

Non-bank lending is on track to surpass $1 trillion in assets under management by 2020, according to a new report from the Alternative Credit Council.

Companies are seeing more favorable borrowing terms in private credit markets as lending competition continues to rise outside the banking system.

Loans are being offered at lower interest rates and with less stringent covenants, according to the Financing the Economy 2017 report released Wednesday by the Alternative Credit Council, the private credit arm of the Alternative Investment Management Association. Fifty-five percent of companies that obtained loans from private credit funds were owned by private equity firms, the group found in this year's survey.

The Alternative Credit Council, which polled 60 private credit managers with about $500 billion in assets under management, said borrowers are able to demand covenant-light loans as the power has shifted in their favor over the past three years. About 67 percent of larger private credit managers, or those with more than $1 billion of committed capital, reported that covenants have become less demanding.

Non-bank lending has been gaining momentum since the 2008 financial crisis and is on track to surpass $1 trillion in assets under management by 2020, the Alternative Credit Council estimated. Direct lending funds, which originate loans to midmarket companies, have been attracting investors with relatively high yields, providing an average internal rate of return of 10 percent to 15 percent, according to the report.

With the private credit industry lending to businesses at record levels, the rise of covenant-light loans may be setting the stage for more distressed investment opportunities. Covenant-light loans, which lack financial maintenance requirements, are more typically seen in the broadly syndicated loan market where financing deals are originated by banks.

"We are getting late in the cycle on the credit side," Anton Pil, global co-head of alternatives at JPMorgan Chase & Co.'s asset management business, said in an interview. "We are spending a lot more time on getting ready for looking for special situations, as the distressed markets are going to pick up again."

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Private credit managers are increasingly lending to the infrastructure and real estate industries, sometimes in collaboration with banks, according to the Alternative Credit Council report.

Jon Rickert, investment director at GAM's real estate finance team, said that while pricing on real-estate financing deals had declined over the past three years, terms were looser before the 2008 financial crisis.

"If you compare it to the kinds of terms available prior to the financial crisis, then the terms that are available are much worse for borrowers," Rickert said. "If you are comparing it to the pricing that was on offer two or three years ago, sure the market is tighter."

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