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Jacob Miller discusses private credit demand and competition for large loans, as the Fed cuts rates
Key Takeaways
- Private credit demand remains extremely strong, with an estimated $500B in dry powder against a $1.5T market cap, leading to fierce competition.
- As rates decline and capital floods the market, the 10-12% yield opportunities that once offered attractive risk-adjusted returns look to be under pressure.
- Smaller private credit lenders are benefiting from regional bank pullbacks, filling the gap for mid-sized loans with strong covenants and collateral with higher yields.
Transcript
Looking at the year ahead with the Fed having cut rates, it's perhaps no wonder that private credit continues to experience extreme demand. I think few investors realize how extreme this demand has been and where that leaves the funds that they're partnering with.
We estimate there's about $500 billion in dry powder in the credit markets, and that's against a total market cap of only about 1.5 trillion. That has a pretty historic ratio.
Now, of course, more loans can go from public high-yield into private. There are other ways to increase the size of the pie. There's tremendous competition, especially for the large mezzanine loans that allow you to, you know, if you want to write only ten loans in a quarter and you have to deploy billions of dollars, they better be big loans.
There are only so many companies who can take out that larger loan. And if you and every other credit fund is trying to lend to the same group, they're going to see that and start demanding lower and lower rates at a time where the Fed is bringing down rates anyway. And so that deal of being able to get 10 to 12% at relatively low risk does look to be under pressure, given what's happening in rates overall and given the amount of dollars that are supposed to flow into loans in the next six months.
Where that crowding really hasn't been an issue is at the end of the loan size market. In fact, there are reasons that that has become really more of a lender's market than a borrower's market.
If we rewind to 2022, we saw the failures of Silicon Valley Bank, First Republic, and a lot of regional banks coming under pressure.
Those were often first-line lenders to small borrowers. Those have stepped back at the same time that rates have, you know, generally been higher than they had been over the last decade. And that's left a gap in the market for who's doing the, you know, 25 to 150 million dollar loans.
There is sort of a cottage industry of private credit managers who specialize in asset-backed finance, in revenue-based finance, in finding ways to lend to folks who otherwise might be a little bit too early or too small to get great banking relationships but can bring the expertise to lend safely and get generally quite a bit higher yields than are available certainly in the public market, but even in that sort of 8 to 12% market that's available via the largest BDCs.
These managers operating small loans tend to be able to get quite a bit above that in terms of yield but, through things like very strong covenants, through strong collateral, mitigate a lot of the risks that come with that higher yield.
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