Private credit: An emerging market

Private credit market

The private credit market has significantly expanded and continues to grow. In early 2024, the private credit market topped US$1.5 trillion and is expected to double in size to US$2.8 trillion by 2028 globally. Private credit today has record investments, with leading investment firms like Blackstone recording over US$200 billion and Apollo over US$268 billion.¹ Debt from private credit funds has become not just a supplement but a substitute to syndicate loans, bank loans and bonds.² Coined as a ‘golden age’ for the private credit market, various capital market trends have facilitated the growth of private credit.

Factors for the rise

Factors for the expansion of private credit markets include stricter lending requirements by banks, which have reduced lending to only specific types of assets, forcing companies to seek out funding sources elsewhere. Moreover, private credit funds tend to be a more favourable alternative for larger corporate borrowers as private credit requires less disclosures, costs and regulations.

Country-specific market trends also matter. For instance, reliance on private credit for risk management and capital allocation have become more attractive for Australia as its bond market is not as substantial as other countries, leading to a nearly AU$200 billion Australian private credit market. Furthermore, there has been a growing interest of borrowers and sponsors for more flexibility and long-term relationships, which private credit provides for.

Another market factor is how debt and equity are increasingly becoming interlinked. New research examines how private credit exemplifies how debt and equity have closely related characteristics. Viewed in the corporate governance lens, private credit lenders often seek for certain control rights (i.e. board representation on borrower’s board, participation in growth of firm) and returns that parallel equity holders.³ Specifically, with the lack of liquid secondary market for private credit and lenders in private credit holding loans until maturity, the loan agreements usually include an equity component or a management role in the company. Moreover, shareholders’ interest and debt holders’ interest also overlap when the private credit fund and the sponsor (private equity) are related or affiliated.⁴ With investors often seeking for profit maximisation and capital growth in the long term, investors are now focusing on private credit for less volatility.

Opportunities

Renewable energy

A key area wherein private credit is likely to dominate is in the renewable energy sector as it is in need of investments from markets. With banks hesitant on fossil fuel transactions due to climate risks and uncertainty, borrowers are turning to private credit for capital. One of the world’s largest private credit fund, Blackstone has recorded the largest funding of US$7 billion for the renewable energy and infrastructure space, particularly in relation to solar, hydro, and additional infrastructure for the energy transition. Blackstone further expects a US$100 billion opportunity in energy transition in the next decade.

Jurisdiction

The Asia-Pacific (APAC) region is having an expanding demand size for private credit. While private credit has traditionally been geared towards the US and European markets, there is growing interest in APAC for diversification purposes. For instance, private credit funds that target Asia have increased by 76% to US$11.2 billion. Although banks still hold a dominant 79% of total credit in the APAC region compared to the 33% in the US, some speculate that APAC is showing trends reminiscent of the period prior to the boom in private credit in the West. However, with geopolitical issues and the governments’ priority in bank lending in Asia, investors are knocking on Australian markets as the focal point of APAC.

Australia’s commercial real estate and asset-based finance

Private credit is having an expanding role in Australia’s commercial real estate. The trend is driven by the slow lending of banks to the property sector in a time where the commercial real estate sector requires capital. Banks have shown growing reluctance in lending to high-risk areas of construction, especially with how construction companies have hit a record number of insolvency cases the previous financial year. According to Australian Securities and Investments Commission (ASIC), Australia’s corporate watchdog, there has been an 28% increase in insolvency over the year with already 2,832 construction industry insolvency appointments in the 2024 financial year ending June. With the increased vulnerability of the commercial real estate sector, reliance on private credit funds is on the rise.

The growth of private credit in this sector has broader implications. Asset-backed finance, which makes up a more than US$20 trillion market and is larger than the corporate credit market, is predicted to be a key area for private credit. While private credit has been focused on corporate credit, asset-backed finance is likely to be the new class of asset for private credit.

Implications

Barriers

While these opportunities exist, there are some challenges that arise from the expansion of the private credit market. As there is no market price to be valued from, some commentators speculate that there could be unintended consequences of mistaken valuations by private companies and increased incidences of fraud.⁵ The transparency is further obscured when considering the lack of disclosure requirements. When the debt market shifted to syndicated loans, more information of companies, particularly of private companies, was available to the public. However, with the reliance on private credit, corporate debt information has been secluded and less publicly available. The decline of available information limits details on the company’s assets, governance, capital structure, and relevant equity and debt values. Consequently, there may be a lack of accountability and transparency with the limited disclosure requirements.

The issue is compounded by how private credit funds have minimal regulations in Australia, with disclosure only required if sold to sophisticated investors. Recent investigation by The Australian Financial Review has also demonstrated that there is reluctance in writing off and notifying on poor performance loans. Moreover, there are also growing situations where funds are given to companies that subsequently default. With the disclosure standards in Australia falling short of the US, ASIC has recently stated that it will take steps to scrutinise against private credit funds. It has recently announced that a taskforce has been set up to determine the state of the private credit market. Whether further regulatory steps or consequences will emerge is still yet to be seen.

Connection with insolvency

Private credit has become a useful tool in periods of distress particularly because private credit lending focuses on financial sponsors who tend to extend the period for default. In fact, during COVID-19 distress periods, private credit had a lower default rate than other leverages. The low default rate can be attributed to the strong relationship between borrower-lender in private credit market which allows the parties to actively tackle any emerging default signs. A recent study by S&P 500 found that payment defaults in private credit remained low during 2020 to mid-2024. With increased reliance on private credit, however, comes risk. Private credit increases leverage and make business more susceptible to financial risks, especially in a market of rising interest rates.

Other impacts on insolvency could be an increase in the so-called ‘zombie firms’ wherein companies do not take actions to reduce debt despite the extensive debt they have.⁶ Experts point out how private credit lenders tend to postpone when they take the losses to avoid damage to their portfolio. Consequently, zombie companies are likely to encounter bankruptcy at later stages of their financial distress, which can subsequently lead to liquidations. With such shift, it will be vital to consider the private credit fund stakeholders in insolvency matters.

Key takeaways

Private credit is becoming a dominant investment class with potential for high returns. In more commercially risky and rising areas of renewable energy and commercial real estate, private credit has been a key asset. The risk of this surge in private credit is the lack of regulation and oversight. However, with movements by regulators, it is likely that there will be growing scrutiny over the private credit market. With the limited information and disclosure on private credit, further findings of its expansion, trends and barriers will be critical to determine how this booming area is shaping the broader commercial landscape on a global level.

The author gratefully acknowledges the assistance of Sarah Oh, a paralegal in the firm’s global restructuring group, for her invaluable assistance in preparing this article.

References

Apollo (2023) ‘Asset-Backed Finance: The Next Evolution of Private Credit’ published October 2023.

ASX (2024) “Understanding Private Credit” Investor Update, March 1, 2024.

Barron’s (2024) ‘Private Credit has a New Target: Asia. It’s a Steep Growth Curve’ published in Barron’s August 2, 2024.

Claire Wilson (2023) ‘Private Credit Eyes Renewable Energy Ops’ published in S&P Global June 16, 2023.

Ernst & Young (2024) ‘Annual Australian Private Debt Market Update for 2024’.

Fang Cai and Sharjil Haque (2024) "Private Credit: Characteristics and Risks," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, February 23, 2024. https://doi.org/10.17016/2380-7172.3462.

International Monetary Fund, Monetary and Capital Markets Department (2024) ‘Chapter 2 The Rise and Risks of Private Credit’ Global Financial Stability Report, April 16, 2024.

Lewis Jackson and Rae Wee (2023) ‘Private Credit Sees Opportunity in Australia Real Estate as Banks Hesitate’ published in Reuters November 6, 2023.

Natasha White (2024) ‘Banks Shying Away From Fossil Fuels Bolster Private Credit Deals’ published in Bloomberg March 26, 2024.

*Note: additional sources that have been explicitly drawn from (including statistics and research references) have been hyperlinked directly and/or footnoted.

1 Jared Ellias Presentation at the Singapore Global Restructuring Initiative (SGRI) (2024).

2 Jared Ellias and Elisabeth de Fontenay, ‘The Credit Markets Go Dark’ 134 Yale Law Journal (2024) Forthcoming.

3Narine Lalafaryan (2024) ‘How Debt Investors are Influencing Corporate Governance’ Columbia Law School Blue Sky Blog published May 30, 2024.

4[4] Narine Lalafaryan, ‘Private credit: a Renaissance in Corporate Finance’ (2024) Journal of Corporate Law Studies vol 24 issue 1.

5 Jared Ellias and Elisabeth de Fontenay, ‘The Credit Markets Go Dark’ 134 Yale Law Journal (2024) Forthcoming.

6 Jared Ellias and Elisabeth de Fontenay, ‘The Credit Markets Go Dark’ 134 Yale Law Journal (2024) Forthcoming.