Private credit may not be forming a bubble as fundraising slows and managers broaden their focus, but there are warning signs pointing to extra uncompensated risk lurking in investors' portfolios.
Portents of possible hazards ahead include:
- Leverage on deals surpassing 2007 levels.
- The proliferation of earnings before interest, tax, depreciation and amortization adjustments based on potential future increased earnings.
- Contracts with few covenants protecting lenders.
Institutional investors' portfolios have been growing for the last several years. According to Pensions & Investments' data of the 200 largest U.S. retirement plans, private credit assets grew by 62% in the year ended Sept. 30 and bank loan assets was up 25%, albeit from small bases in both categories.
"As rates have continued to go on a downward trajectory leading investors to seek more yield, the role of credit and private credit has continued to expand," said James Zelter, New York-based co-president and CIO of Apollo Global Management LLC's $215.5 billion credit business.
Private credit managers' combined assets under management grew to a record $812 billion as of June 30, up 78% from $753 million as of Dec. 31, 2018, and more than three times the $194 million total AUM as of Dec. 31, 2007, Pre-qin data show.
Despite dipping in 2019 following a record year in 2017, fundraising for private credit strategies remains strong. Managers of private credit have a record amount of dry powder, $297 billion, according to a McKinsey & Co. private equity report released in February.
"We continue to watch companies get as much debt as they are seeking," said Andrea Auerbach, a managing director and head of global private investment research at Cambridge Associates LLC in Menlo Park, Calif.
Credit managers are flush with capital and dry powder, she said.
"It still feels like it's go-go-go," Ms. Auerbach added.