Private credit investors preparing for 2024 can look to the rapidly evolving markets we’ve seen throughout 2023 for hints of what’s to come. In this outlook, we explore three pivotal themes that have dominated headlines this year and, in our view, are likely to create opportunities for parts of the private credit market going forward.

• Banks stepped back from the lending market, fueling the continued rise of nonbank lenders.
• Recent private credit allocations have shifted to less traditional areas of the private credit market amid an overall decline in fundraising.
• Covenant-lite deals have become increasingly common in private credit (but investment-grade private placement hasn’t been susceptible to this change).

Private capital benefiting from bank retrenchment 

The aftermath of multiple bank failures this year has led to an extreme pull-back in traditional lending that continues to impact the private credit industry. Higher interest rates, a challenging macro environment, and the collapse of SVB, Credit Suisse, and other regional banks have resulted in banks reining in risk, creating more opportunity for private capital to step in and fill the void. 

The rise of nonbank lenders accelerates a multidecade shift — spurred by the global financial crisis (GFC) and a changing regulatory environment — that continues to be felt across the private credit landscape. For example, regional banks experienced a 900-basis-point decline in overall market share within the CRE debt markets¹ while the market share for private CLO transactions in 2023 has more than doubled from 2022.² The tremendous private credit growth story was fueled by bank retrenchment in 2008, and private funds are once again taking center stage amid the current credit contraction. 

In our view, the transition away from traditional lending sources and toward private credit is likely to continue.

Shifting allocations amid a decline in private credit fundraising

Private debt fundraising has declined sharply in 2023. While the fundraising environment has been difficult for the asset class, we have seen a clear shift in allocations as clients invest beyond direct lending. Fundraising for direct lending strategies — the core of many private debt allocations – declined 21% year over year³ as asset owners looked to allocate to “satellite” strategies. 

Specifically, riskier parts of the private debt market saw strong fundraising momentum, highlighted by increasing allocations to mezzanine strategies. Fundraising for mezzanine strategies has nearly doubled YoY, accounting for more than a quarter of all private debt fundraising to date.³ While investors may see strong returns from junior debt strategies today, the increased risk associated with these strategies will likely remain a key focus for LPs. 

Additionally, we believe asset-based financing (ABF) and investment-grade private credit both remain in focus for asset owners seeking a strong diversifier to corporate credit allocations. Through 2022, the private ABF market has grown around 67% since its peak in 2006⁴ and this growth persisted in 2023. Similarly, demand for investment-grade private credit strategies continues to grow as asset allocators look to lock in higher investment-grade yields and diversify fixed income allocations. 

Although the fundraising environment has been challenging, we believe private credit remains well positioned amid a changing macroeconomic and regulatory backdrop that provide tailwinds for the asset class. We think today’s markets offer a variety of private credit strategies that can be used to meet a range of investment objectives. We continue to see strong relative value in the investment-grade space as well as opportunities for clients seeking asymmetrical return profiles that have the potential for attractive returns combined with the downside mitigation potential of the asset class.

Increasing importance of covenant discipline

As we move toward the end of 2023, we have heard continued concern about covenant discipline within the broader private credit markets. Specifically, direct lenders have started to drop key financial covenants as they look to engage in larger deals and take additional share away from traditional bank lenders. Based on recent data from Moody’s, the majority of the larger private credit loans (US$500+ million) have indeed dropped maintenance covenants.⁵

Despite concerns about the erosion of key lender protections within the broader private credit market, financial covenants remain near the top of the priority list within the investment-grade private placement market. In our view, this is particularly relevant in today’s volatile market.

We continue to see private placement deals maintaining robust covenant packages (primarily maintenance-based, rather than incurrence-based) that provide strong lender protections. The private placement industry has been able to maintain this covenant discipline despite the increasing size of deals in the US private placement market (average deal size in the market has moved to above US$330 million this year).⁶ With increasing potential for elevated defaults, maintaining strong covenant protections will be key for private credit investors. We saw firsthand how the covenant protections in this asset class helped private placements to remain resilient through the GFC, and we firmly believe that the markets’ discipline in maintaining covenants will result in continued resilience moving forward. 

Bottom line on private credit investing in 2024

In 2024, we believe private credit investors are likely to continue to see changing lending sources, allocations, and deal terms. In our view, amid these shifts, the asset class remains well-suited to help investors navigate an increasingly complex market. In particular, we believe areas like investment-grade private placement, which maintains strong covenant packages, may be compelling in the year ahead.

¹Sources: MSCI. Data as of 30 June 2023; “Record collapse: New report shows extent of regional bank pullback in CRE lending,” Bisnow, 27 September 2023. | ²Source: Citigroup. Data as of 5 October 2023; “The New Kings of Wall Street Aren’t Banks. Private Funds Fuel Corporate America,” The Wall Street Journal, 8 October 2023. | ³Source: Preqin. Data as of 30 September 2023. | ⁴Sources: Analysis by Integer Advisors and KKR. Data as of May 2023  | ⁵Sources: Moody’s; “Private credit lenders giving up protections to win bigger deals,” Bloomberg, 26 October 2023. | ⁶Source: Bank of America USPP Market Snapshot, 30 September 2023.