How does private credit meet various financing needs for companies that often can’t access the syndicated loan market?
Corporate borrowers, especially middle-market firms, have increasingly relied on private credit from private equity firms in recent years. Most of this takes the form of so-called direct lending, senior secured commercial loans used mainly to finance working capital or growth. This trend reflects the growing retreat of banks from the broadly syndicated loan (BSL) market.
About 10% of all small and medium-sized firms in advanced economies and over 20% in emerging market economies report being credit constrained, often due to a lack of collateral, according to researchers at the Basel, Switzerland-based Bank for International Settlements. Not surprisingly, Fitch Ratings finds that direct lending by private credit funds grew at a compound annual rate of 16.2% over the past five years and estimates that direct lending now accounts for about half of all loans outstanding by credit funds.
Private credit funds serve a wide range of industries. However, concentration is beginning to grow. Manufacturing, technology, media and telecommunications, and industrials used to make up over two-thirds of all deals, according to PitchBook. But their share has shrunk to less than 40% today. Other industries, including cleantech and life sciences, are capturing an increasing portion of the total.
After direct lending, the next largest share of private credit funds’ fundraising comes from distressed debt, which is usually issued for corporate restructurings, although its share has declined since 2014. As of 2023, distressed debt accounted for approximately 10% of the new capital commitments to the funds.
Mezzanine loans, which are short-term hybrid capital based on companies’ cash flow rather than assets, continue to be a relatively important form of private lending among larger companies, addressing unmet demand for subordinated debt in the BSL market. In recent years, research firm Preqin reports that mezzanine lending has experienced significant growth compared to other categories.
Finally, funds offering other types of lending, including special situations, venture debt, and multi-strategy funds, have captured an average share of 14.5%, or about $26 billion in new commitments each year.
As an alternative to subordinated debt, PitchBook also reports that private credit funds have been increasingly targeting asset-based finance. While ABF loans have not significantly increased as a percentage of total fundraising, Fitch expects that asset-based finance will lead private credit expansion in the near- to medium-term, while real estate credit, infrastructure credit, net asset value financing, subscription finance, and structured credit will also continue to grow substantially.
Observers such as Lenore Palladino, associate professor of economics at the University of Massachusetts, and her research assistant Harrison Karlewicz, suggest that private credit ABF-loans may eventually fund a significant portion of intellectual property royalties and data center subscriptions.
