Private equity and hedge fund firms are lending to companies at the highest rate ever, driving up competition in the sector and forcing funds to look outside the US for more opportunities.
Private credit, which has sprouted while post-crisis regulation curtailed the amount that banks were willing to lend, is growing at a rate not seen since the hedge fund industry boom in the 1990s.
Private credit funds managed about $600bn at the end of last year, according to data from research firm Preqin.
That figure could grow to $1tn by 2020, according to two industry lobby groups, the Alternative Credit Council and the Alternative Investment Management Association, and the law firm Dechert, in a report released on Wednesday.
"The opportunity set is expanding, but the amount of competition for those opportunities is also expanding as the industry has seen more and more entrants and as the capital raised by the private debt funds has increased," said Gus Black, a partner at Dechert who specialises in advising on these deals. That "has resulted in pricing pressures".
The amount of dry powder — money that is not being deployed — is also at a low, despite the record level of funds the industry is managing. About one-third of the money being managed is currently not invested, the lowest level since the end of 2013 and among the lowest since 2000.
Investors are piling into private credit in search of sometimes double-digit returns as interest rates stay low, some hedge fund strategies suffer and private equity firms sit on record levels of ready cash.
Recent examples of deals include Elliott Management providing part of the financing for the Chinese investor Yonghong Li to buy AC Milan for €740m, CQS providing a £22m loan to a telecoms company and KKR loaning €125m to a Dutch holiday park developer.
About two-thirds of the investments target terms of between two and six years, while the sweet spot for loan size is between $25m and $100m for nearly half of debt funds, according to the new report.
For funds, returns can vary widely depending on the riskiness of the borrower and the terms of the deals. Stuart Fiertz, the chair of the ACC and co-founder of the credit-focused hedge fund Cheyne Capital, said funds could aim for returns in the mid-teens if they are investing in distressed companies and using leverage, but most investors are targeting returns in the high single digits to low double digits.
Those returns may be stretched as more funds pile into the strategy, leading to better loan terms for borrowers. Credit funds, in turn, are turning to Europe and Asia for more opportunities.
But Mr Fiertz said that despite "a proliferation of lenders" in the middle-market space, where "the market might be too crowded or susceptible to too much money chasing too few deals", there is plenty of demand for loans in infrastructure and real estate.
Private credit has also reduced some risk in the banking system, Mr Black said.
"What it has resulted in is a much better alignment between the duration of capital and the risk," said Mr Black, who worked on the research. "What the banks were doing was taking short-term deposits and then lending those on a five-year term loan, so you had a massive liquidity mismatch on the bank's ability to recover the loan, whereas a five-year fund will raise money for five years and lend it for five years."
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