Some of the world's largest investment firms are preparing for a shakeout in the $770 billion market for private debt, making it a prime target for takeovers.
Private equity managers, many of whom had piled into lending when banks cut back risks after the 2008 financial crisis, say the market has become so competitive that it will be increasingly difficult for smaller firms to raise money. Meeting at this week's SuperReturn International conference in Berlin, executives were asking whether there's a "private credit glut" after assets nearly tripled in the past decade.
"We will see consolidation in the direct-lending market as private-capital firms look for scale in the asset class," said Kewsong Lee, co-chief executive officer of Carlyle Group, at Thursday's show.
Private credit has been a key growth area for firms such as Blackstone Group, KKR and Carlyle. Their capital has helped firms find financing even if they are too small or high risk for the public debt markets. These borrowers typically pay a premium and the yield on offer has attracted swathes of investment in recent years.
But with interest rates moving higher and signs of an economic slowdown mounting, the market is getting tougher. Overall, $110 billion was raised in 2018, coming down from a record $129 billion the year before. The proportion of capital raised by first-time fund managers fell to an all-time low last year, according to Preqin.
"The industry will continue to grow but the bigger platforms will benefit more than the smaller ones," said Symon Drake-Brockman, managing partner at Pemberton Capital Advisors. "There will be winners and those that get consolidated."
Franklin Resources agreed to buy Benefit Street Partners to expand into private credit in October, adding $26 billion in assets under management. French buyout firm Eurazeo bought a 70% stake in Idinvest Partners, a Paris-based company that offers private debt in addition to venture capital and investment in private equity firms, last year.
The private debt industry has grown to almost $770 billion in assets under management as of June from $275 billion in 2009, according to a report from Preqin. But the environment for new lenders is getting tougher. Most fund managers that Preqin surveyed said they expect competition for assets will be the biggest challenge this year.
"Like any asset class, as it develops and evolves more people are in it, competition increases but that's the natural evolution," Michael Arougheti, chief executive officer of Ares Management, said in an interview from the SuperReturn conference this week.
A pioneer in private credit, Ares is moving deeper into Europe and Asia and pushing to expand strategies like investing in structured credit and asset-backed securities that it expects could be as big as direct lending.
The competition is also prompting lenders to offer more flexible credit agreements to borrowers, removing covenants in the documentation that may protect them in times of financial stress.
"We expect to see continued consolidation in the credit space, driven both by M&A activity and the underperformance of credit managers during the next cycle," as an economic slowdown weeds out some of the newer, untested funds, said Robin Doumar, managing partner at Park Square Capital.