Commercial Insights Economy and Markets

Trends in the private credit industry: what to expect in 2024

The private credit industry has seen exponential growth since the Global Financial Crisis. Learn what to expect in the coming year.

May. 01, 2024 4-minute read

The private credit industry has seen exponential growth since the Global Financial Crisis (GFC). Investments in this space have grown from roughly $250 billion of assets in 2008 to nearly $1.7 trillion today, eclipsing both the high-yield bond and leveraged loan markets, according to the Federal Reserve Opens in a new window. .

Within the broader private credit alternative asset class, middle market direct lending has taken the most substantial share, with approximately $800 billion of assets. Investors have been attracted by the sector's strong performance during the GFC and the COVID-19 pandemic. This trend has further strengthened in a rising interest rate environment where traditional fixed-income investments have struggled.

Challenges of a high interest rate environment

Rapid interest rate increases in 2022 and 2023 led to a combination of economic uncertainty and increased discounts on companies cash flows, decreasing what buyers of private companies were willing to pay. This drove M&A activity in 2023 to the lowest level in a decade. For those transactions completed, deal quality was generally poorer, as sellers often sold only under duress. Sellers with the ability to delay a sale typically did in hopes of a more attractive environment.

Still, 2023 had a silver lining for private credit funds. High interest rates drove predominantly floating middle market direct lending yields within reach of anticipated near-medium-term private equity returns, which are expected to decline driven by their ability to apply a lesser amount of higher cost leverage to their portfolio of companies. Fortunately, while these higher interest rates have stressed middle market companies' cash flows, default rates have not increased substantially to date. Additionally, the lull in new platform transactions enabled all parties to focus on supporting their existing portfolio companies' operational initiatives and integrating smaller add-on acquisitions.

Improving market conditions

The prospect of a soft landing for the economy, on the back of potential interest rate decreases in 2024, have tightened the bid ask spread between buyers and sellers. Private equity funds are particularly eager for increased deal activity. When these funds delayed sales in hopes that market conditions would improve, their annualized growth metrics have, in many cases, been dragged down by the longer hold periods. The resulting decreased flow of distributions to their investors have created a cash flow drag that has slowed investment in new funds.

While asset managers have increasingly sought to utilize continuation vehicles and NAV loans to quicken the return of some investor capital, these methods have generally received a lukewarm reception compared to the certainty of traditional portfolio company sales. Reservations aside, NAV lending, especially from direct lenders looking to find new ways to support their PE clients, has established itself as a legitimate way to improve or protect mature portfolios.

Financing environment normalizing

In further support of increased M&A activity in 2024, capital markets have sprung back to life with substantially increased collateralized loan obligation and unsecured bond issuance. These avenues of debt fundraising are important sources of investable capital to pair with the equity raised by middle market direct lending funds. The combination of an increased willingness to transact and improved access to the required capital are both materially positive trends.

While the resulting modest uptick in M&A activity has been a positive trend, volumes have remained more modest than historical averages and have resulted in strong competition for high-quality borrowers. This dynamic has begun to erode some of the premium pricing that many middle market direct lenders enjoyed over the last few years. While this readjustment has been met with some resistance, it signals a return to a more familiar and predictable environment.

Navigating a dynamic market

In these market conditions, working with a long-term partner that has substantial expertise in middle market M&A provides an edge in an increasingly dynamic and competitive market. Thanks to its extensive experience, CIBC's Non-Bank Finance team understands how to help your firm navigate the current environment successfully. Its offerings span a fund's life cycle, from early subscription lines, first-out revolvers and management fee lines, to the later back leveraging of established loan portfolios. The combination of incremental services, such as a dedicated financial institution treasury management team, a full suite of custom derivatives solutions and the ability to issue letters of credit, enable their clients to focus on what they do best.