Private Credit vs. Broadly Syndicated Loans: Not a Zero-Sum Game

Recent headlines in the financial press have portrayed the public and private credit markets as rivals fighting over the same turf, with the fortunes of one rising as the other’s fall. The competitive narrative specifically pits the upper middle market segment of private credit against broadly syndicated loans (BSLs); the lower middle market segment seldom enters this ring and is thus relatively immune from these competitive pressures.

It’s true that the private credit markets have ballooned in recent years amid a pullback in traditional bank lending and other dynamics, rising from roughly $725 billion1 in 2018 to roughly $1.7 trillion2 in 2023 (see chart below). The broadly syndicated loan market has enjoyed a fairly steady climb as well, reaching a high of $1.4 trillion3 in September 2022 before leveling off and dipping slightly in 2023.

As the chart below illustrates, however, growth in these markets is not a zero-sum game: the rapid expansion of private credit has not come with an offsetting decline in BSLs. Although the two markets at times find themselves in competition, in many ways they can be complementary, with room for both to thrive – and this dynamism offers greater diversification of financing sources for sponsors and borrowers and may lead to more stable credit markets.

Private Credit’s Ascent Has Generally Not Come at the Expense of BSLs

Growth in private credit and broadly syndicated loan markets (US$ billion)

Source: Federal Reserve Note, “Private Credit: Characteristics and Risks” as of 23 February 2024 (underlying data from Preqin); and Pitchbook as of 31 March 2024 (BSLs). Private credit figures include invested capital and dry powder; *2023 data in charts for private credit as of 30 September 2023. 2023 data for broadly syndicated loans as of 31 December 2023.

We believe aggregate growth in the credit markets is less about competition for the same assets and more about which market is best positioned to meet the moment. For instance, in 2023, private credit markets stepped in as banks grew less willing to underwrite leveraged loans, providing financing for higher-risk transactions that otherwise might not have been completed at all (see chart). The public loan market contracted during that period, but the tide has since begun to turn, with a strong rally in leveraged loans during the first quarter of this year flipping the script as demand outpaced supply.

The Give-and-Take Between BSLs and Private Credit Reflects Changing Market Conditions

Syndicated loans and direct lending takeouts (US$ bil.)

Source: Pitchbook as of 31 April 2024.

We expect this dynamic to continue as market conditions change, and we see ways in which these markets could even be mutually supportive. Companies with BSLs facing tough refinancing conditions, for instance, could turn to the private markets for financing, potentially sidestepping defaults. For issuers, competition between the markets is a clear benefit, allowing them to opt for whichever market offers more attractive features – especially critical at a time when rates are near historical highs.

Public and private credit have distinct benefits and risks for investors and sponsors

Investors are in part drawn to public credit markets because their money can be put to work quickly in liquid vehicles that offer broad diversification across industries and issuers. At the same time, sponsors who opt for the BSL market often enjoy lower debt costs and better terms with regard to ticking fees (fees imposed to compensate for lag time in a deal), which is important during periods when transactions may face increased regulatory scrutiny and delayed closings. BSLs also offer more flexibility for sponsors as to documentation and credit agreements.

Private credit, on the other hand, offers investors higher yields than BSLs given their illiquidity, with a roughly 157 basis point average yield premium over the past 10 years4 (see chart). They are also low-volatility (though not necessarily low-risk) investments given the lack of trading, and they have lower correlations with public markets. For sponsors, private markets offer greater certainty and quicker execution of deals since they are not subject to banks’ willingness to underwrite them or to the ability of banks to syndicate the debt when faced with the vagaries of CLO demand. Private deals also generally offer greater flexibility in underwriting and do not require credit ratings, and often allow for the use of payment-in-kind (PIK) or PIK/toggle loans, second liens, and holding company debt. Sponsors’ direct (and often long-term) relationships with companies allow them to step in if a borrower faces headwinds.

Private credit offers higher yields to compensate for illiquidity

Private credit yield premium

Source: Refinitiv LPC 1Q24 Private Deal Analysis; yield premium represents the difference between upper middle market private credit loans and BSLs.

One concern for investors, of course, is that in courting issuers, borrowers in both markets may sweeten terms in ways that allow standards to slip. Indeed, public deals have begun to offer some of the same inducements common to private transactions, such as delayed-draw term loans. The potential for mispricing of risk and erosion of investor protections are legitimate concerns which, in our view, call for an active approach to investing that assesses each transaction and borrower’s specific risks.

Peaceful coexistence is possible

The recent growth of private credit is not the end for public loans, and we believe the two markets will instead complement one another in general while potentially competing at the margin. We view the upper middle market portion of private credit as more vulnerable to the latter, with transactions of $350 million and up more likely to see some competition, while smaller lower middle market deals should be largely immune.

We believe private credit steps in when either 1) public loan markets become closed to sponsors with respect to certain transaction types, including second liens, “storied” (sub-investment-grade) credits, and the like; or 2) sponsors are seeking certain structural options (e.g., PIK loans), flexible underwriting, or other benefits discussed here. The upshot is that where some contraction in the size of the public loan market may occur during certain periods, this will ebb and flow over time in step with changing conditions.

It comes down to what matters most to sponsors and the level of demand within each market at a given point in time. We believe this dynamic could potentially have more negative implications for upper middle market private credit than the BSL market, given that public credit already pays lower spreads and is less onerous for borrowers, requiring only weak documentation and no covenants. We don’t expect private credit to reach true parity with public loans on the cost of debt or documentation, given that some illiquidity premium must be in place to attract borrowers to this space.

The relative attractiveness of private versus public credit markets for investors will come down to the risk-adjusted return potential of each market along with the investor’s diversification and liquidity needs, among other factors – and market conditions will continue to inform these determinations.

We believe successful investing in both leveraged loans and private credit requires an active approach founded on in-depth issuer research, robust risk assessment, and a strong understanding of the opportunities and challenges of each market. The question for investors is how to allocate between public and private credit markets to tap the benefits of each amid an economy and markets in flux and uncertainties about the potential timing and degree of interest rate cuts. We favor a flexible approach that seeks to help investors reap the benefits of both public and private credit by determining how best to deploy capital given current and expected conditions.