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Robust Private Equity Activity Has Potential to Bolster Private Credit
What we are seeing
Private credit expanded to approximately $1.5 trillion at the start of 2024, up from $1 trillion in 2020, and is estimated to soar to $2.6 trillion by 2029.1 Amid tighter bank lending, borrowers continued to value the speed, certainty and flexibility of private credit solutions. Sponsored middle-market loan activity remained relatively resilient during the past year, partly supported by demand for incremental or add-on financings.
Increasing financing costs put pressure on some borrowers in older deals, but overall credit quality has been consistent in the past year. We expect deal flow will continue to increase amid generally constructive financing markets, with private equity (PE) focused on deploying its substantial dry powder and returning capital to founders. PE dry powder is forecast to close out 2024 at a record high $1.6 trillion.2
What we are doing
Amid the current economic environment, we continue to take a proactive approach, which includes closely analyzing companies' earnings and free cash-flow generation. As always, we focus on maintaining a portfolio that is diversified across sectors and we avoid deeply cyclical capital-intensive businesses. Instead, we lend to sponsors in non-cyclical industries, such as software, insurance and residential services, because they can typically maintain cash flow levels through market cycles. Higher interest rates have put pressure on certain borrowers, especially for deals from older vintages.
What we are watching
An industry trend we are watching is the use of payment-in-kind (PIK). As rates only decline moderately and interest-rate hedges roll off, focus on the ability for borrowers to manage their cash interest burden remains high. These borrowers are favoring structures which offer PIK flexibility. In the right situations, PIK interest may be appropriate, but will depend on the rationale for use, the business fundamentals and the underlying capital structure.
We see opportunity for growth across the diverse private credit landscape. Asset-based finance, including investment grade, is an area we believe will continue to experience outsized growth. We also think the momentum in opportunistic or hybrid capital will continue to expand. As levered borrowers look for refinancing in this higher-rate environment, we believe they will look for creative capital solutions within the private markets. Other areas where we see opportunity include the unsponsored deal segment, growth companies requiring hybrid capital and real estate lending.
1 Preqin, Future of Alternatives 2029 Report. As of December 2024.
2 Ibid.
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