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Written by: Jordan Jackson
The growth of private credit has been nothing short of impressive. In the U.S., private credit assets under management (AUM) have grown from an estimated $40bn in 2000 to $1.2trn as of 3Q23, with AUM more than doubling since 2019[1]. While almost 30% of the recorded AUM is considered “dry powder” i.e., capital that has been raised but has not yet been committed, its growth and implications for credit markets cannot be ignored. Moreover, since mid-2021 the size of the U.S. high yield (U.S. HY) market has shrunk by almost 25%[2] leading investors to consider if companies that would normally issue in the public market are opting for private capital as a funding source.
To understand these shifting dynamics and determine how to embrace this growing asset class, investors should consider: What’s driving the growth of private credit and the decline in high yield and, if private credit deserves a strategic allocation in a broader credit portfolio?
It should first be emphasized that while, in certain cases, publicly traded high yield companies tap the private markets for capital, it is not the primary driver of the growth in private credit or decline in the high yield market. In fact;
- The high yield market has shrunk largely driven by rising stars far outpacing fallen angels. Since 2021, close to $300bn of high yield credits have been upgraded to investment grade (IG) (rising stars) relative to just $40bn of IG falling into junk territory (fallen angels). Despite this migration of high-quality companies out of high yield, this is part of a general trend towards higher quality with over 50% of the US HY market rated BB or higher, the highest quality rating for junk bonds[3].
- Private credit has grown largely due to banks stepping back from issuing loans to lower quality issuers due to increased bank regulation. Since 2000, banks and non-banks have gone from splitting (~50/50) syndicated loan financing to corporations to non-banks now supplying ~75% of financing[4].
- Since the GFC, across smaller, lower-rated leverage buyout (LBO) deals, private equity sponsors have favored floating rate debt provided by private credit funds instead of a combination of HY and floating rate. The increase in floating rate loans with more limited call protection as the debt financing for LBOs has supported private credit growth and contributed to the lower quality (CCC/NR) HY market shrinking.
As a result, U.S. HY is now more concentrated amongst larger companies/issuers, whereby private credit provides a key source of financing for smaller companies and more niche business models. The average new issue bond size in the public U.S. HY market has doubled since 2008 and given companies are staying private for longer, private credit provides a very import source of capital for promising micro- and middle-market companies.
On the latter question, and as highlighted in our piece: A new perspective for credit investors, investors may be best served by implementing permanent strategic allocations to three distinct components of the credit markets;
- Ultra-high quality: IG corporates, Treasuries, and municipal bonds;
- Broad credit: Securitized credit, traditional public high yield, emerging market debt and,
- Speculative credit: Illiquid private credit that seek high potential returns through a combination of greater credit risk, leverage, or illiquidity.
In summary, private credit is not without risk; stress is rising in private credit given its floating rate nature while high yield tends to be more fixed rate. That said, it is not cannibalizing the traditional high yield market, but rather supplying important financing to companies that may not be equipped both in size and quality to issue in the public HY market of today. Given this, a bucketed approach across the credit spectrum seems appropriate to diversify credit exposure and interest rate risk.
U.S. Private Credit AUM has reached the size of the U.S. High Yield market
Growth in U.S. Private Credit AUM, market value of U.S. High Yield, USD Billions
Source: Bloomberg, Preqin, J.P. Morgan Asset Management. Data are as of May 9, 2024.
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[1] According to Preqin. Data are as of May 9, 2024.
[2] Based on the market value of the ICE BofA US High Yield Index. Decline in market value is from 6/30/2021 to 4/30/2024. The market value decline is a combination of higher rates pushing the average bond price lower and a decline in the par amount outstanding.
[3] As shown on GTM slide 34 – Credit maturity and default risks
[4] As shown on GTA slide 55 – U.S. banks and credit market participants