Demand for private credit continues to surge

Private debt has been expanding for the past decade. Banks reined in commercial lending as regulators tightened rules following the global financial crisis, while the post-pandemic surge in inflation that sparked sharply higher interest rates has further boosted demand for non-bank loans. These surged to their highest level in at least 20 years in 2023, with direct funds reaching more than US$540 billion in assets last year, up from US$70.8 billion a decade earlier, according to the research provider PitchBook Data. Firms likely raised more than US$200 billion last year alone for private debt funds.[1]

Moreover, relatively high returns means that there is plenty of investor demand for private credit. Returns for private debt funds beat those of private equity for a second straight quarter in the third quarter of 2023 (the latest period for which data is available). Historically, investors have expected bigger returns from private equity because of its inherently riskier nature.

Private credit takes off in Australia as bond demand wanes

Australian pension funds are the latest to be attracted to private credit. Bloomberg reports that the institutions are losing their appetite for bonds as interest rates peak. It says that the Construction & Building Unions Superannuation Fund (Cbus), for example, which has A$90 billion (US$59 billion) in total assets, is planning to triple its global allocation to private credit over the next 18 months. Meanwhile, the Hostplus Superannuation Fund, which has around 1.7 million members and over A$100 billion (US$66 billion) under management, is seeking to add to its already record holdings of the asset class.

Furthermore, Australia’s largest pension manager, AustralianSuper, which has A$300 billion (US$199 billion) under management, has over A$7 billion (US$4.5 billion) invested in private credit globally. AustralianSuper wants to triple its exposure in the coming years through a mix of direct lending by its in-house private credit team and strategic partnerships with best-in-class specialist managers.[2],[3]

Attractive returns are among the factors luring these pension funds. Bloomberg quotes Brett Chatfield, Chief Investment Officer at Cbus in Melbourne, as saying “there’s still very good opportunities to earn low double-digit returns.” By comparison, US investment-grade bonds yielded an average of 5.4% in early April, down from a 52-week high of 6.4%.

Real-estate direct lending boom

The factors driving demand for private credit are accentuated in the area of real estate. Since 2022, higher interest rates, increasingly cautious lenders and falling property prices have eaten into returns. There is also a pressing need to refinance maturing debt, estimated at US$2.8 trillion in US commercial real-estate debt alone by the end of 2028.[4]

That background is creating opportunities for alternative providers of capital to lend on well-located, high-quality buildings at attractive yields and terms. Moreover, the outlook for real estate may be improving, given that interest rates in the advanced economies are likely to ease in the second half of the year. Rebounding REIT prices and tightening credit spreads are another good sign, since they traditionally herald a pickup in the sector.

Growing provision of private credit to the real-estate sector can be seen across the world as pension funds, sovereign wealth funds and insurance firms look for robust returns that are hard to find in bond and equity markets. Last November, for example, Reuters quoted Paul Notaras, Executive Director at Barings Real Estate Australia, as saying investors could expect returns from 9% to 11%, with the added security of loans pledged against real assets like condos or warehouses, often with a 30% to 40% equity buffer.[5]

There is little sign of the boom in private credit coming to an end. Indeed, interest appears to be gaining strength as major institutional funds increasingly target this sector, lured by yields that are likely to remain attractive given the likelihood that interest rates globally will remain well above pre-pandemic levels.

Key takeaways

Demand for private credit continues to surge as banks curtail lending and amid the prospect of sustained elevated interest rates.
Real estate is an area where interest is particularly strong, partly as a result of the pressing need for refinancing.
We anticipate that growth will continue, given the likelihood that interest rates globally will remain well above pre-pandemic levels.

Sources