We hear so much about private credit these days and how big it is, how big
it's gotten. Give us your sense of just how big it is
right now and why it's gotten this big. So when we talk about private credit,
let me just zoom out quickly. We're talking about lending that is
happening outside of the banking system and that could be in corporate real
estate, infrastructure, consumer. I think a lot of the recent dialogue
that that folks are paying attention to is more along the opportunity in
corporate lending. That's the most evolved in the most
developed market here in the US and globally.
In terms of sizing, no one quite knows this because a lot of this is in private
hands. But order of magnitude.
The private credit market for corporate than the U.S.
is about 1 billion. Juxtapose that with CNI loans in the
banking system that grew to two and a half times that and almost at parity in
terms of size. But the leverage loan in high yield
market. So what effect is the increase in
interest rates had on the private credit business?
Obviously, it's affecting a lot of business right now.
It's harder to get loans if you can get them at all.
They're more expensive. I think private credit has tended to
outperform when rates are going up. Two main reasons.
Number one, the structure of the loans are short duration and floating rate.
We reprice every 30 to 90 days. So as rates are going up, the return is
going up. That obviously in an environment where
we're seeing a lot of volatility in the equity markets and valuations are
challenged in the high grade markets, private credit is a place where people
can actually go to benefit from rising rates.
The the flip side of that, obviously, is that as rates are going up, that service
becomes more alleging or leveraged borrowers.
And so part of the conversation today is as you're generating this at this rate
earn, at what point does the incremental interest rate challenge companies?
I would say as we sit here today, still really strong fundamental economic
performance within the portfolios and not any signs of stress really making
their way through as a result of the rate hike.
Might just pick up on a couple of things you said there, because I talked to one
investor who said there's no such thing as truly bullet proof in business, but
these are close to it. And I guess it's because of the two
things you mentioned, the short duration and also the fact you got floating
rates. So if interest rates go up, you're
protected. Well, I hope that person you spoke to is
an areas investor already. But if they're not right, which
I bulletproof is always something that you don't want to talk about in
investment. But I would agree at this point in the
cycle, private credit is a good place to be floating rate.
As we said, short duration, but also senior secured.
Though, if you think about where these exposures sit in a company's balance
sheet or relative the value of an asset. Today, most private credit loans are
sitting in the upper half of the capital structure, which means that there is
institutional equity supporting those loans.
Dollar for dollar, there is a significant amount of equity valuation
that would have to deteriorate before you begin to have a conversation about
principal loss on private credit. Mike, you mentioned areas investors and
I wonder whether you're having, if anything, an easier time in getting
investors these days because interest rates going up necessarily affect the
value of equities. Just because the discount rate, it makes
it less attractive, has private credit and has become more attractive relative
to equities as an alternative investment?
I think so. You know, in areas managers post to
three hundred and fifty billion dollars of assets globally and we have funds
that we offer across the old spectrum, including private equity.
I would say as a general observation, investor appetite or door play equity
product is pretty muted right now simply because, as you point out, valuations
are challenged. And if you think about the drivers of
return in that market, earnings growth is going to be muted.
Availability of leverage is difficult. Austin Capitals ISE.
So private credit does offer some pretty attractive relative value.
And I think going into this part of the cycle, a lot of institutional and retail
investors were under allocated private credit.
And so when they're grappling with the denominator effect from valuation
iteration and the public equity market and the high grade market, private
equity is probably where you're feeling it the most.
I think the private credit markets, people are still under allocated,
though, even though their alternative allocation may be lower, they're able to
allocate that. I've read also, Mike, that the size of
the loans is going up. You can handle much larger loans than
you did, say, 5, 10 years ago at. Absolutely right.
I mean, one of the biggest drivers of growth in private credit in the US and
now globally was bank consolidation and the increase in size in the public
market. Viewed through that lens as banks that.
Consolidated, it's more difficult for them to service smaller borrowers.
And as the public debt and public equity markets have grown and moved towards
larger borrowers as well. There's just a much brighter white space
for private credit and private equity for that matter.
A man with larger capital solutions. So as that opportunity set has grown and
as folks like us have scaled capital, the average investment size has
absolutely increased. Just to put that in perspective, when we
started this business 20 plus years ago, a good sized borrower in this market was
probably twenty five million dollars would be better cash flow.
And today, average cash flow in our portfolios is pushing one hundred
million. How much of the growth of private credit
has been because the banks have been more regulated.
They have had to move back out of that space.
And I guess the follow on to that is do you see a prospect of more regulation
coming from Washington as private credit's gotten so big?
Yeah, I think that a little bit of a I don't say a false narrative, but a
misunderstanding of what's been driving the growth of these market.
So bank consolidation is really the primary factor.
So if you look at the evolution of private equity and private predator over
the last 20 to 25 years, it really started with the consolidation of the
middle market. Bank landscape in the big money center
bank. So if you look today, there are 50
percent of the number of banks in the US than there were 20 years ago.
As a result of that, what one may have expected, which was that all of this
capacity would have stayed in the system.
The larger banks are now focused on larger borrowers and more liquid part
business. The regulatory overlay is less about
regulation of the banks and really more about the regulatory capital framework
and the profitability of this business. On bank balance sheet, one thing that I
think is misunderstood by most is that the banks are still very active
participants in and around private equity and private credit landscape.
They're just acting the business in a different way, lending money to folks
like Aries, supporting the buyout business through the syndication of
loans. So they're still very, very active.
I just think that they've moved away from being primary holders of middle
market credit, which actually makes them funding like where does the next leg of
growth come? For areas and for private credit more
generally, is it taking more market share away from banks?
Is it moving into new areas? I know areas in the United States also
to some extent in Europe, not in Asia. Yeah, we're seeing what I would call
horizontal and vertical growth so graphically.
We've been expanding into Europe over the last in years and now have a
meaningful private credit business across the eurozone.
We are now meaningfully rolling our business across the Asia-Pacific region.
So there will be geographic expansion as these markets continue to evolve along a
similar trajectory with a lot of the same trends that we saw in the US.
There are also new markets that are opening is as institutional investors
are being more attracted to private credit and the private market ecosystem
is growing. We're seeing opportunities in places
like infrastructure lending, real estate credit, alternative credit.
But I think we're still in the early stages of the development of these
markets. And my expectation would be if we can
continue to demonstrate durable performance through cycles, then the
appetite for the asset class overall continue to grow quite.