Private credit is creating a quiet revolution in debt finance
The explosion in private credit investment is transforming funding for mid-market businesses as direct lenders push into markets previously dominated by banks. Despite the government’s worries that investors aren’t backing UK Plc, it shows there’s still interest in British businesses from UK pension funds and insurers, according to Fenton Burgin, debt advisory partner at professional services group S&W.
He says the expanding private credit market is creating “a quiet revolution” in debt finance for mid-market businesses and is pushing down funding costs. But it also comes with increased complexity, he warns.
“The rise of private credit has been one of the most profound changes in institutional investment in the last two decades,” he says. “It has huge implications for businesses looking to borrow.”
Private credit takes off
According to Preqin, the private credit market grew by 50% from 2020 to the start of 2024, from $1tn to $1.5tn. That growth has accelerated recently, Burgin notes, due to geopolitical instability, higher taxes, trade tariffs and interest rates staying higher for longer, creating volatility in public markets. By 2029, it is forecast to reach $2.6tn.
The reason is that institutional investors hungry for yields have increasingly recognised that private markets can offer higher returns and lower volatility than public alternatives. Over the last 15 years, direct (private) lending has delivered 150bp higher returns than comparable public bonds, with much lower volatility than listed shares. There has only been one year (2008) where returns have been negative
The result is the popularity of private credit with investors has “exploded”, said Burgin, as fundraising in the sector has shown. Last July, direct lender Ares Management announced it had raised $15.3bn for its third senior direct lending fund (along with bank loans to create a lending fund of $34bn). A month before, HPS Investment partners raised $14.3bn. In September, Intermediate Capital Group’s flagship direct lending strategy raised $17bn.
“This is what is missing in debates around institutional investment in the UK market, the lack of UK IPOs and worries that institutional capital is fleeing to New York,” says Burgin. “Politicians panic that pension funds and other institutional investors aren’t backing UK plc, but there’s plenty of appetite for British businesses.
“It’s just that we’ve seen a fundamental shift away from small public AIM listed and FTSE250 stocks to private credit – a boom lending to the mid-market. It has been a quiet revolution in institutional investment.”
Direct lending for M&A and the mass market
That is good news for mid-market businesses seeking funding, with an expansion of private credit at both ends of the market.
On the one hand, the successful fundraising drives of private credit managers have left them with huge stocks of capital, enabling them to finance ever larger deals. The result is that companies seeking to finance significant working capital or M&A requirements are no longer dependent on issuing bonds in the public capital markets, explains Burgin.
Rather than looking to the high yield market, with its uncertainty, complexity and requirements for ratings and public disclosure, companies are turning to direct lenders. Many of these specifically target the mid-market, where they can find the returns and deal sizes they want.
At the other end of the market, specialist private credit funds are increasingly offering an alternative to banks for asset-based lending (ABL), receivables, real estate, stock and vehicle finance.
“Direct lenders are increasingly financing ABL, invoice discounting and property deals, as they break into the mass market lending space.”
The competition at both ends is already bringing prices down – further expanding the appeal of private credit for mid-market borrowers.
“Structures priced at Libor plus 8% a couple of years ago are priced at SONIA plus 5.5% today,” says Burgin. “Crucially, the pricing differential for debt between large-cap companies and the mid-market is diminishing significantly. Mid-market businesses aren’t having to pay the premium to borrow what they once did.
The appeal of private credit is only likely to grow, he adds, and increased capital is likely to fuel more activity for M&A, particularly corporate carve-outs, as well as smaller deals and new solutions.
Not so simple: Private credit complexity
The benefits private credit has brought the mid-market come with a cost, however, Burgin warns: Significantly increased complexity.
Much of that is just down to the increase in potential lenders: “Five years ago, around 20 direct lenders operated in the mid-market, alongside traditional alternatives. Today, there are more than 100. Consequently, a company looking for finance that might previously have had five to ten potential lenders to consider could now be looking at a list of 50.”
With vastly increased options, finding the best funder for a deal is significantly more challenging.
The other layer of complexity is, in part, the result of how traditional lenders have responded to the increased competition. Some are partnering with private credit funds, as with Lloyd’s Banking Group’s tie up with alternative investment manager Oaktree Capital announced last July and AGL Credit Management’s exclusive cooperation agreement with Barclays Plc.
For banks, such deals allow them to access the growing private credit market while limiting their risks so they can still meet their capital requirements: “They take the higher positions in the credit structure, the senior secured debt that is paid first in the event of a default, while the direct lender takes a lower mezzanine or junior debt position, but also a greater share of the returns,” explain Burgin.
Knowing your lenders is getting harder
While this means there is more capital available looking to finance mid-market deals, it also means loans with more complex credit structures and less clarity as to the identity of the ultimate creditors. That can quickly become an issue if the borrower runs into headwinds and needs to negotiate with its lenders.
“If you hit choppy waters, knowing who will be sitting on the other side of the table is vital,” says Burgin. “The attitudes of a big bank and direct lender to repayment problems are likely to be quite different.”
Navigating complexity and understanding the options available is more challenging, but for those that can, the good news is that lenders are open for business and keenly looking to support mid-market UK companies.