The Ebb and Flow of Activity from Lenders in the Private Credit Market
Atlanta, GA — Borrowers looking to tap into the growing private credit markets should be aware of the fundamental ebb and flow, or lender velocity, and the factors that can affect appetite for new deals.
The market is fast-growing and incredibly dynamic, with Configure data showing that between 6-month tracking periods, top lenders can go from representing more than half of all credit proposals to as low as roughly 15%. Furthermore, accounts that routinely represent between 35% and 45% of all activity were completely inactive in the prior period.
In the piece, Configure Managing Director James Hadfield explores the concept of lender velocity and influencing factors such as increased market demand resulting from increased regulation for traditional banking, larger funds leading to optionality, and the overall need for fund rebalancing.
Read the full article below.
The Ebb and Flow of Activity from Lenders in the Private Credit Market
Borrowers tapping the blossoming private credit markets should be aware of the fundamental ebb and flow of how credit fund interest in new opportunities may expand or contract, given the multitude of macro factors shaping this fast-growing yet still nascent market. Configure data shows that between 6-month tracking periods, top lenders can go from representing more than half of all credit proposals to as low as roughly 15%. Furthermore, accounts that routinely represent between 35% and 45% of all activity were completely inactive in the prior period.
A specific credit fund’s appetite for new deals and overall assertiveness in the market — or what one could describe as “lender velocity” — adds variability to the decision tree and pool of relevant potential lenders for new opportunities. Configure attributes the variability to factors such as the life cycle of a fund, the stage of the fundraising, the number of deals they are actively pursuing in the market, increasing amount of retail capital being raised by credit fund, concentration limits imposed by credit funds own leverage providers, and amount of dry powder, amongst many others.
However, there are causes to this ebb and flow outside of the fundraising process that affect lender velocity and appetite for new deals, as well as effects that come hand-in-hand with the change. Factors such as increased market demand for private credit resulting from increased regulatory issues from the traditional banking market, more funds in the market leading to more optionality, and the overall need for fund rebalancing — there is more to the story than first meets the eye.
Increased Regulation for Traditional Banking has Caused More Private Credit Activity
Increased activity begets increased optionality, and with variability in rates, banks have seen escalating regulatory levels with new capital tiers versus three, six, or 12 months ago. Factors such as risk management, lending capacity, regulatory compliance, and, of course, market confidence all play a role in determining these tiers. With increasing interest rates and hold sizes becoming significantly smaller, banks must take a step back and evaluate what standards fit their mold for lending. This has provided a deep market supply and demand gap that has been filled by private credit.
As we know, private credit is not subject to these strict regulations — they are more agile with their money and can independently set these tiers based on their factors. They are putting their dry powder to work at an unexpected velocity, turning over funds more quickly, and there is a need to increase fundraising to meet the demand.
Higher Competition and Bigger Funds
Recently, larger asset managers with established brands and newly launched private credit funds, as well as established funds seeking to “blitzscale,” have moved into the market with aggressive tactics, such as essentially “running a sale” on capital and offering highly competitive terms and pricing — specifically lower fees and carry rates. Configure has seen this new group win bids with such attempts to capture market share and deploy capital. As a result, these larger/mega funds are growing rapidly, as more capital and the desire to put money to work expeditiously are creating opportunities for borrowers. As quoted in Configure’s Private Credit Quarterly, private credit fundraising of $5B+ funds has nearly doubled, accounting for 43% of all capital raised in 2023 versus 22% in 2022.
The con, however, is that smaller asset managers have struggled to raise capital at the same rate and, thus, have seen an impact on their hold sizes and renewal desires for their underlying credit investments. Configure has seen a number of borrowers in 2023 constricted with capital-constrained credit funds.
Funds Need to Rebalance
Private credit funds have fundraising cycles, the lifespan of which can affect lender velocity. As a firm shifts gears to fundraise for its next fund — especially in light of increased activity — its ability to lend into active situations will be more limited. When fundraising slows, “gaps” can be created in funding, which is often more pronounced at smaller credit funds than larger ones.
Additionally, portfolio construction and diversity are more essential in private credit than private equity, given the leverage facilities most credit funds utilize. Private credit funds have targeted portfolio construction, with sector and industry being a key focus. Once those allocations have been fulfilled within a sector, that fund will be limited to offering capital on what may have been a previously active relationship for a borrower.
An Effect: Supplier Concentration
As borrowers look for smart pools of capital, it’s important to keep an eye on the ever-changing landscape of aligned lenders in any given situation. Historically, PE has been able to have access to sources of lending from a small group of, say, three to five relationships. These lenders’ own credit funds were growing at a level that running into capacity constraints wasn’t an issue that materially impacted borrowers — with few exceptions, all credit funds were winning. Now, though, in the current phase of private credit, you see more of the haves and have-nots, and for borrowers, it is important to balance the best terms with the support of solvent, growing capital providers.
Additionally, the changing landscape has shed light on how having a small group of lenders across a firm’s PE portfolio can be detrimental. For example, if a PE firm has defaults in its portfolio and many of those loans are with one singular lender, if they default on one, that could result in an issue for the rest of the loans in the portfolio.
The lender could no longer have the patience to deal with the other delinquent payments and, because of that, become stricter on terms and need to redeem. That change could open a PE firm to more systemic risk across their portfolio, particularly if their portfolio companies are highly leveraged. While having several credits with one lending account can be advantageous from a relationship basis, larger capital supplier concentrations of capital are no different than large supplier concentrations in companies PE invests in — it introduces high risk, and in this case, one that can be addressed.
Tracking Lender Velocity
With the market changing daily, many PE funds feel they need to rely on something other than their typical cohort of go-to lenders. Factors such as competition, fund rebalancing, and increased bank regulation are driving lender velocity, therefore causing an enhanced focus on supplier concentration and decreased risk.
As private credit continues to blossom and create more and more optionality for middle-market borrowers, working with a credit advisor highly active in the market will help those borrowers stay ahead of the curve and identify lenders with the highest probability of engaging in and pursuing an opportunity.
Jamie has held a variety of positions across middle market credit, investing, and advisory platforms.
Prior to joining Configure, he was a Managing Director at Guggenheim Securities, where he joined in 2013 to expand Guggenheim’s reach in the middle market. Before joining Guggenheim, Jamie established the Atlanta office for Cerberus Capital Management with a focus on direct lending and equity investment activities. While at Cerberus his responsibilities included sourcing of new debt and equity investment opportunities, underwriting transactions and portfolio management. Prior to joining Cerberus, Jamie spent three years at Houlihan Lokey after beginning his career at IBM and Standard & Poor’s. Jamie is a FINRA General Securities Registered Representative (Series 24, 7, 63).
Outside of the office Jamie enjoys spending time with his family, outdoor activities including golf, hiking,biking, and the occasional triathlon. He and his family reside in the Morningside neighborhood of Atlanta.