Private credit: From alternative to strategic asset class

Private credit is becoming an increasingly mainstream asset class, as a growing number of investors consider providing loans as a strategic component of their portfolios. Growing demand for non-bank financial loans is fuelling the size of the market, with private credit assets under management expected to reach USD3 trillion by 2028¹.

The rise of private credit started after the Global Financial Crisis, as tightened financial regulations and a lower risk appetite among banks opened up a financing gap that was filled by non-bank lenders. By engaging in this kind of financing, investors were able to diversify their portfolios by taking on assets that carry an illiquidity risk premium.

A broadening asset class

Since then, the type of loans on offer has broadened significantly, said Robert Fauber, President and Chief Executive Officer, Moody’s, who pointed to three growth areas.

The first is asset backed finance, which is taking assets that are traditionally funded by banks – such as consumer loans – and packaging them into private credit loans. Increasingly, the underlying asset is something more esoteric, like fleet financing and intellectual property royalties. Mr. Fauber said that financing data centres will be another important growth area for these asset backed loans.

The second area is fund finance. This includes subscription lines and net asset value loans (NAV loans) that allow a private equity firm to borrow in a way that is backed by the assets in its funds. Mr. Fauber added that fund financing accounted for a significant portion of Moody’s new mandates in its financial institutions franchise in 2024.

The final growth area is geographical in nature. In Asia, private credit is still in its early days, with low levels of penetration compared to the US and Europe. But that could be changing as there is growing interest among the region’s big investors – including Australian superannuation funds and Japanese insurers.

Creditor-debtor dynamics

The panel discussed current pricing trends in private credit, where credit spreads have tightened as the market has become more crowded. Part of the attraction to borrowers is that as public markets suffer from increased volatility, the private counterpart can provide greater execution certainty with only a relatively small increase in the cost of borrowing.

Borrowers of private credit benefit in other ways from the popularity of the asset class. This can be seen in looser loan covenants, which increasingly include options for the borrower to delay payments by an average of three years, or the removal of conditions related to the change of the control, where a lender would be able to revisit the loan if there is a change in ownership of the borrower.

There is also an interplay between public and private markets. The market for high-yield bonds has shrunk, as issuers turn to the private market to raise funds. The strong level of demand for the remaining high-yield debt has led to very tight spreads and elevated prices.

Expanding the investor base

Although the market for private credit is now quite sizeable, it is still very small in comparison with the public market. In order for private credit to continue scaling, it requires a broader range of investors to participate in provide non-bank loans.

Retail investors will likely become part of the private credit story. In the US for example, there is so much capital invested in private and private pensions funds that if even a small proportion is allocated to private credit it would provide an enormous boost to the market.

The other potential growth area is in insurance, which is already highly active in the private credit market. In Asia however, insurers still have a small exposure to private credit. Again, there only needs to be a relatively small shift in allocation for these giant investors to substantially grow the market.

The panel discussed how in the case of retail investors, it will be important to ensure that they understand the new products and structures that will be offered to individuals.

Highlighting the illiquidity of private credit investments is essential, as a portfolio needs to have a level of exposure to less liquid assets that meets the risk profile and investment goals of the investor. Less liquid exposures make more sense for long-term investors, like pension funds and wealth portfolios, where the investor aims to realise their returns after a number of years.

More broadly, the private credit market will be able to grow by asset managers increasing the base of assets that are accessible in the private market and finding innovative ways to incorporate them into their client portfolios. In short, innovation will play a key role promoting the further development of private credit.