The Golden Age of Private Credit

Welcome to the thirty-ninth Pari Passu newsletter.

Today, we are going to learn more about the hottest topic of the moment: private credit.

Defining private credit and a brief history

Traditionally, companies and transactions got their debt financed by public debt issuances or banks. Today, private debt markets have eaten a large share of the market. What lead to this structural change? Before we start, you should know private debt (or credit) is defined as financing provided by non-bank lenders to companies.

According to a report from Ares, this structural change was driven by a series of steps. The first stage was significant bank consolidation, which had a profound impact on the supply of capital to small businesses. In fact, regional banks (that serviced the middle market) consolidated into larger banks which preferred to provide larger credit facilities to larger customers. As a consequence, less capital was allocated to smaller borrowers. This trend was then amplified by new bank regulation post‐GFC.

Banks were compelled to comply with fresh regulations like Dodd-Frank and Basel III. These regulations mandated banks to bolster their capital reserves, significantly tighten their lending criteria, and improve their reporting standards, among other new administrative obligations. Consequently, in the wake of the GFC, banks reduced the variety of their loan offerings, especially for financing assets that are not easily converted to cash, and adopted a more cautious approach to risk. In addition, as banks became less willing to carry high-risk loans on their balance sheet, non-bank corporate lenders emerged to take on this role, particularly for small and medium-sized businesses. In the case of larger corporate borrowers who can tap into widely syndicated loan markets, collateralized loan obligation (CLO) and loan fund managers started to supplant banks as the primary holders of loans originated by banks. Similarly, middle-market borrowers and private companies that do not have access to public financing markets increasingly turned to private credit funds.

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