Five trends to watch in US private debt

The growth of speciality finance is helping to drive the market.

As investors look to diversify allocations beyond corporate direct lending, new strategies are emerging to push the US private debt market ahead in 2023. Here are five key trends to watch over the next 12 months.

1 Fundraising has slowed to a seven-year low

The latest PDI fundraising data shows just 84 credit funds successfully raised globally in the first half of 2023. This was the lowest number since 2016, while the $84 billion of capital raised showed a steep drop from the $119 billion raised in H1 last year.

Jeff Frank, head of capital solutions and strategy at Twin Brook Capital Partners, says competition for investor capital is intense among private credit managers. Investors, especially institutional investors, are demanding flexibility from managers to help them solve their specific needs, he says.

2 Horizons are expanding

But institutional investors continue to appreciate the private credit opportunity, even with the slump in fundraising. Subordinated and mezzanine debt strategies are taking a greater share of investor dollars and there is a concerted push into speciality finance areas – either asset-based or asset-backed – with real estate a growing area of interest.

Jason Strife, head of junior capital and private equity solutions at Churchill Asset Management, says its junior capital dealflow has actually increased from last year, as sponsors are focused on structuring deals correctly in the higher rate environment, and in many instances, looking for fixed cash and payment-in-kind (PIK) coupons. “In our view, it is an excellent time to be deploying capital,” he says.

3 LPs are keen on asset-based lending

Speciality finance is on the march – especially asset-based strategies. According to a KKR white paper, the private asset-based finance asset class grew 15 percent from 2020 to 2022 and is expected to increase from $5.2 trillion to $7.7 trillion by 2027, with the US responsible for the majority of the transactions.

LPs are keen on asset-based lending because they find comfort in being secured by an identifiable asset, as opposed to cashflow. “Whether the asset is equipment, inventory or aircraft, having that security to lean against is of great interest,” says Robert Molina, managing director and head of origination at Briarcliffe Credit Partners.

4 Flexibility is required

The challenging macro environment has highlighted the ability of lenders to pivot in response to market dynamics. Dan Pietrzak, global head of private credit at KKR, says KKR’s strategy has not changed with the macro environment, but where they spend their time in terms of the asset classes has.

“We toggle depending on market conditions, and certain asset classes that we would have been focused on a year-and-a-half ago are now less of a focus today,” he says. “We want to be across a bunch of asset classes, be nimble and be flexible with how we invest into this, and that has not changed since day one.

“We had a big thematic around US housing, and we are at least a bit more cautious there today, though we don’t think the bottom is going to fall out of that market. We are also a little more cautious on the consumer globally; there are specifics around jurisdictions but inflation is impacting everybody. Anything we are doing in consumer today is prime, with a focus on higher credit quality.”

Tyler Gately, managing director and head of client portfolio management – global private finance at Barings, believes the conditions are ripe for more evergreen structures. “Where we go from here is probably more optionality, more flexibility and ultimately more structural choice for investors,” he says.

5 Underwriting discipline is paramount

M&A levels may have slowed, but bank retrenchment is creating genuine opportunities and the more conservative credit terms favour debt funds, fund managers say.

However, underwriting discipline is important, and disciplined underwriting requires data.

“Most clients want that data in-house, but it’s a daunting task to build internally,” says Greg Myers, global sector head of debt capital markets at Alter Domus.

“This is why we’re confident that outsourcing will continue to offer a compelling value proposition for the GPs looking to make the most of this particular moment in the credit markets.”

But Kipp deVeer, CEO of Ares Capital, says there are not significant signs of distress in portfolios today – at least not yet.

“We are seeing a resilient yet slowing economy, and companies that have taken on a fair amount of debt are dealing with higher base rates,” he says.
“We don’t think that creates a significant level of stress, but we do expect defaults in most lending asset classes to go up a bit next year.”