Key Drivers Behind Private Credit’s Growth:
Historically, private credit has been an attractive investment ripe with growth opportunities fueled by attractive risk-adjusted returns — even during periods of economic uncertainty and market volatility.
However, as regulators force banks to continue to tighten lending practices and private credit becomes a more sought-after investment class, investors are increasingly wondering whether it’s become overfunded, creating the perception that it’s too risky.
At PennantPark, we believe the opposite to be true. This article argues why private credit is not overfunded and discusses what investors and borrowers should consider when evaluating investment opportunities.
Growing Demand from Middle Market Borrowers
Middle market demand for private credit is not slowing down anytime soon for three key reasons:
Since the Global Financial Crisis (GFC) and the introduction of new regulations, banks have continually pulled back on lending. These regulations require banks to hold more capital on their balance sheets to protect against defaults and loan repayment failures, but that tends to leave middle market borrowers out to dry.1
Private credit stepped up to fill this void left by banks. As a result, middle market companies, especially those backed by private equity sponsors, are increasingly turning to private credit.
At the end of 2023, private credit AUM was $1.7 trillion. According to Pitchbook, the private debt market will grow to $2.7 trillion by 2028.2 These estimates suggest that non-bank lending will remain robust, and private credit funds will continue to play a critical role in meeting this need.
At the same time, specific industry sectors in the middle market continue to demonstrate resilient growth, making private credit an attractive and sustainable investment.
At PennantPark, we focus on serving the “core” middle market (earnings of $10 to $50 million) across five defensive sectors: healthcare, government services, business services, consumer, and software and technology.
The Bureau of Labor Statistics projects these sectors to experience demonstrable wage and salary growth over the next decade.3 This projected labor market growth could indicate that capital inflows into private credit are aligned with where the market is experiencing sustainable growth.
Finally, this growth in demand from middle market borrowers is primarily fueled by companies’ desire to remain private longer. In fact, we’ve witnessed a 47% decline in the number of public companies trading on the market, dropping from around 8,000 to just over 4,000 total publicly traded companies since the 1990s.4 More middle market companies are turning to private equity firms to seek the capital they need to fuel future growth rather than the public markets.
Pitchbook projects private equity to grow to $9.7 trillion in the next five years, potentially propelling private credit to $2.7 trillion.5
Today, direct lenders like PennantPark make up 82% of PE-backed loans, an increase from under 30% 30 years ago.5 As private equity and private credit are expected to grow in parallel, this would indicate that the capital allocated to private credit isn’t excessive but essential to serving this market segment.
An All-Weather Asset Class
Historically, private credit is considered an all-weather asset class.
Private credit markets can weather volatile market conditions better than public markets. After all, private credit’s lower correlation to traditional asset classes helps protect against market downturns and ensure stability throughout different economic cycles.
Additionally, private credit is less sensitive to changes in macroeconomic conditions, like high inflation, than traditional investment classes. Because private credit is often structured on floating interest rates, it acts like a built-in hedge against high inflation. As rates controlled by central banks rise, so do private credit loan interest rates, making private credit a more attractive option than other investments that are more negatively affected by high inflationary environments.
Therefore, investors looking for capital preservation and contractual long-term returns may find the dependability they seek in private credit, making the asset class a highly sought-after investment option.
Private Credit is Not Overfunded
While fear of overfunding private credit is understandable due to increased competition and recent spread tightening, the above factors support our claim that private credit is not overfunded.
After all, demand for private credit is clearly growing. As of the end of 2023, the global private credit market was valued at nearly $2 trillion, approximately ten times its size in 20096, and demand for funding continues to surpass supply.
Additionally, private credit provides an opportunity to capitalize on equity-like returns with less risk than traditional asset classes. For example, while private credit generated a 6.3% annual return in 2022, the S&P 500 fell 24%, demonstrating resilience while other investments struggled.
Finally, as the economy reacts to the news of President Trump’s re-election, we’re beginning to get a clearer picture of how changing macroeconomic conditions could impact the outlook for private credit. Potential higher-for-longer interest rates, tax cut expectations, and government spending could create opportunities for private lenders to step in and provide much-needed funding in a favorable business environment.
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1: Source: The way companies borrow money is changing forever. Business Insider
2: Source: PitchBook: Private Capital’s Path to $20 Trillion – Q2 2024. Represents Pitchbook’s good case scenario.
3: Source: Industry and occupational employment projections overview and highlights, 2023–33, Bureau of Labor Statistics
4: Source: World Federation of Exchanges, World Bank, PitchBook. U.S. Census Bureau.
5: Source: PitchBook: Private Capital’s Path to $20 Trillion – Q2 2024. Represents Pitchbook’s good case scenario.
6: Source: McKinsey & Company. McKinsey’s Private Markets Annual Review 2023. McKinsey & Company, 2023, www.mckinsey.com/industries/private-capital/our-insights/mckinseys-private-markets-annual-review-2023.
7: Source: LSEG LPC’s Middle Market Connect The Middle Market Opportunity, 2Q-2024. PitchBook LCD, Dec 31, 1994 – Dec 2022.