4 Reasons to Consider Private Credit Despite the Headlines
In September, we laid out a high-conviction view on private credit and were especially enthusiastic about a subcategory of private credit, direct lending. While there is risk of default, and direct lending may not be appropriate for all investors, here are four reasons why we continue to have a constructive view on direct lending.
• 1. Direct lending yields still stand out.
Leveraged, or syndicated, loans stand out in public corporate credit because they are still offering investors solid compensation. Leveraged loans are very similar to direct loans, with the notable difference that leveraged loans are tradeable securities and direct loans are not. We believe in exchange for less liquidity, direct lending offers investors 250 basis points of yield, per annum, above leveraged loans.
• 2. Loan growth appears to be healthy, not bubble-esque
The direct loan market is often cited to be $1.7 trillion in total loans outstanding. If we just focus on the United States and remove dry powder, we estimate outstanding direct loans in the United States to $475 billion, compared to total principal value of $925 billion for domestic high yield and $1.4 trillion for the USD Leveraged Loan Index (as of Q2 2023). The direct loan market is smaller than many assume.
• 3. Underwriting standards and fundamentals are solid
While lending standards have loosened a bit recently, they remain solid overall. Average net leverage for borrowers has increased recently but remains well below 2021 and early 2022 levels. Furthermore, risky “covenant-lite” loans (which come with less protection for lenders) are not prevalent in direct lending deals. After analyzing a proprietary set of our J.P. Morgan Investment Bank data, we’ve found that only about 20% of direct lending deals completed during the last 12 months are covenant-lite. By contrast, about 90% of syndicated loans are covenant-lite.
• 4. Defaults may rise further. We think investors may be well compensated for the risk.
Following the spike in borrowing rates over the past two years, defaults rose in public markets. However, they did so from extremely low levels. The increase only brought default rates back to their long-term median. Defaults are a fact of life in leveraged finance and it is possible defaults will increase further as debt costs rose following rate hikes by the Fed. Still, with we think investors may be well-compensated for that risk.
Rick Barragan is the Managing Director,
Los Angeles Market Manager, for J.P. Morgan Private Bank.
[email protected] | (310) 860-3658
privatebank.jpmorgan.com/los-angeles
Source: J.P. Morgan Private Bank Insights, April 17, 2024. “Four reasons to consider private credit despite the headlines” By Thomas Kennedy, Chief Investment Strategist; Chris Seter, CFA, Global Investment Strategist; Brian McDonald, Head of Alternative Investments, Global Investment Opportunities, J.P. Morgan Private Bank.
