Private Credit: Opportunity or overstretch?

In this article

• Private Credit Overview

• Private Credit market Size 2013 -2023

• Average Annual Credit Losses

• Loans Types in Private Credit

• Annual Loan default rates

• Private Credit Fund Investment by entity

• Conclusion

The private credit market has surged to $2.1 trillion in 2023, marking a significant leap from $1.84 trillion in 2022. This growth represents a 15% compound annual growth rate (CAGR) over the past decade, driven by demand for alternative financing options that offer flexible structures and attractive yields. North America remains the largest regional market, reaching $1.25 trillion in 2023—roughly 60% of the global total—while European private credit stands at $0.27 trillion, showing a 17% CAGR. The sector's “dry powder” reserves, or undeployed capital, have also grown to $0.49 trillion, reflecting investors’ readiness to seize new opportunities amid rising interest rates and tightening liquidity.

The private credit landscape showcases an evolving risk-reward balance, particularly when comparing average annual credit losses of 0.9% to those of other credit instruments like high-yield bonds (1.47%). Within this market, secured loans dominate deal types, accounting for 55.8% of transactions across various sectors, including software and healthcare. Meanwhile, fund investments remain largely segmented, with public pension funds contributing 19% of total commitments, leaving 35% of sources unidentified. Lastly, annual default rates for sponsored and non-sponsored leveraged loans have declined to 2.3% and 7.8%, respectively, underscoring improved performance in recent years. 

This report unpacks these trends, offering insights into the key drivers and potential pitfalls shaping private credit’s next phase.

Private Credit Overview

This diagram provides an overview of the private credit market structure, illustrating the key players, intermediary fund types, and their connections to corporate borrowers. End investors, including pension funds (PFS), insurance corporations (ICs), sovereign wealth funds (SWFs), and retail investors, play a foundational role in funding private credit. Each investor group has unique characteristics, such as long-term investment horizons and high wealth levels, contributing to the stability and growth of the market. Retail investors also contribute indirectly, primarily through Collateralized Loan Obligations (CLOs), which involve banks providing leverage to diversify credit exposure and risk.

Intermediary vehicles in private credit, such as closed-ended and open-ended funds, Business Development Companies (BDCs), and CLOs, act as conduits between investors and borrowers. These funds often target floating-rate loans with heavy covenants, offering lenders a degree of control and customization. The funds cater to mid-market and corporate borrowers, providing flexible financing solutions, particularly for small to medium-sized firms with potentially higher leverage needs. This structure enables investors to tap into the private credit market’s high-yield potential while addressing the capital needs of various corporate borrowers.

Private Credit market Size 2013 -2023

The private credit market has witnessed impressive growth over the past decade, expanding from $0.5 trillion in 2013 to $2.1 trillion in 2023. This 15% compound annual growth rate (CAGR) underscores the rising demand for private credit as an alternative to traditional financing, driven by its flexible structures and appealing yields.

Within this market, North America remains dominant, reaching a market size of $1.25 trillion in 2023, which accounts for roughly 60% of the global total. Europe also shows robust growth, with its private credit sector expanding from $0.05 trillion in 2013 to $0.27 trillion in 2023, at a higher CAGR of 17%. Additionally, "dry powder," or undeployed capital, has grown steadily to $0.49 trillion, reflecting investors' readiness to capitalize on new opportunities in an environment of rising interest rates and tightening liquidity.

Market Growth and Demand:

o The private credit market grew from $0.5 trillion in 2013 to $2.1 trillion in 2023, a 15% CAGR over ten years. This rapid growth indicates a strong demand for alternative financing sources that provide flexible terms and attractive yields compared to traditional lending options.

o Private credit has gained traction as institutional and private investors increasingly seek opportunities beyond the public markets, particularly as interest rates rise and traditional credit sources tighten.

Regional Breakdown:

o North America remains the largest private credit market, increasing from $0.26 trillion in 2013 to $1.25 trillion in 2023. North America’s dominance is partly due to its developed financial ecosystem, high demand for alternative financing, and robust investor base.

o Europe has experienced even faster growth, with a 17% CAGR, expanding its market from $0.05 trillion to $0.27 trillion over the same period. This growth reflects Europe’s increasing appetite for private credit, supported by rising regulatory and economic challenges in traditional banking sectors.

Dry Powder (Undeployed Capital):

o "Dry powder" has grown from $0.18 trillion in 2013 to $0.49 trillion in 2023, at a CAGR of 10%. This growth in undeployed capital indicates strong investor interest and highlights the sector’s potential for future deployment.

o The significant reserves of dry powder suggest that investors are prepared to seize emerging opportunities in the private credit space, especially in response to the current economic environment marked by tightening credit conditions and rising demand for private debt.

Outlook and Implications:

o The growth in private credit and dry powder reserves signals a favorable outlook for the sector. With increased investor interest and ample undeployed capital, the private credit market is well-positioned to expand further.

o As demand for alternative funding sources grows, private credit may continue to play a critical role in supporting mid-market and corporate borrowers, providing flexible capital amid the current liquidity and interest rate environment.

Average Annual Credit Losses

In evaluating the risk profile of various credit instruments, average annual credit losses provide a key measure for understanding the potential downsides investors face. As illustrated, private credit shows a favorable risk profile with an average annual credit loss of 0.90%, which is lower than high-yield bonds at 1.47% but slightly higher than leveraged loans at 0.81%. Bank loans demonstrate the lowest average credit loss rate at 0.31%. These statistics highlight private credit’s position as a middle-ground option for investors seeking higher yields than traditional bank loans while taking on less risk than high-yield bonds.

High-Yield Bonds:

o With an average annual credit loss rate of 1.47%, high-yield bonds exhibit the highest risk among the four categories. This level of risk correlates with the higher returns generally associated with high-yield bonds, which attract investors willing to tolerate increased default probabilities for potential yield.

Leveraged Loans:

o Leveraged loans carry an average annual credit loss of 0.81%, reflecting a balanced risk-return profile. This risk level is lower than high-yield bonds but close to private credit, indicating that leveraged loans may appeal to investors seeking a relatively stable investment with moderate returns.

Private Credit:

o At 0.90%, private credit’s average annual credit losses are slightly higher than those for leveraged loans but considerably lower than for high-yield bonds. This makes private credit an appealing choice for investors seeking yield enhancement without the heightened risk of high-yield bonds.

o The loss rate also demonstrates private credit’s suitability for institutional investors looking to diversify their credit portfolios with relatively manageable risk exposure.

Bank Loans: 

o With the lowest average credit loss at 0.31%, bank loans represent the safest option among these instruments. The low-risk profile of bank loans may be attractive for risk-averse investors or those looking for stable, lower-yield investments.

Loans Types in Private Credit

Given the unique risk profile of private credit, the sector offers a diverse range of loan types tailored to meet varying financing needs across industries. This data illustrates the distribution of loan types—secured, mezzanine, unitranche, and other loans—across key sectors like software, IT infrastructure, healthcare, and industrial machinery. Secured loans account for the majority across all sectors, followed by mezzanine financing, which supports firms with more flexible capital structures. The data reveals sector-specific trends, indicating varying levels of risk tolerance and investment preferences across industries.

Secured Loans:

o The most common loan type, with 55.77% of deals overall, reflecting investor preference for lower-risk, asset-backed lending.

o Highest concentration in industrial machinery (63.46%), highlighting this sector’s reliance on secured financing for capital-intensive operations.

o Also prominent in healthcare (57.37%) and IT infrastructure (50.25%), showing a balanced risk appetite for sectors with strong collateral.

Mezzanine Loans: 

o Comprising 25.71% of total deals, mezzanine financing is used widely in sectors requiring flexible capital, balancing risk with the potential for higher returns.

o Software (30.5%) and healthcare (23.82%) sectors show significant mezzanine activity, reflecting a need for growth capital with subordinated risk profiles.

o Lower percentage in IT infrastructure (18.01%) and industrial machinery (19.9%), where investors may favor lower-risk loan types.

Unitranche Loans:

o Less common overall, representing 7.12% of deals, typically appealing to middle-market companies seeking streamlined financing structures.

o Software has a higher unitranche usage (22.37%), possibly due to the sector’s growth potential and flexibility needs.

o Minimal presence in healthcare (5.81%) and industrial machinery (7.84%), where capital structure may lean toward traditional secured loans.

Other Loans:

o Making up 11.62% of deals overall, this category includes specialized loans that do not fit traditional classifications.

o IT infrastructure (20.62%) shows the highest allocation here, likely due to the sector’s diverse financing needs.

o Lower percentages in other sectors, indicating that most sectors prefer more conventional loan structures.

Annual Loan default rates

The resilience of private equity-sponsored companies during periods of economic stress is a well-documented phenomenon in credit markets. Sponsored leveraged loans—those backed by private equity sponsors—tend to demonstrate lower default rates than their non-sponsored counterparts. Private equity sponsors often bring capital support, operational guidance, and strategic oversight, which help stabilize sponsored companies during economic downturns.

This chart compares annual default rates for sponsored versus non-sponsored leveraged loans over three critical periods: the 2009 financial crisis, the 2020 COVID-19 pandemic, and the current year (2023). The comparison highlights the role of private equity sponsorship in mitigating credit risk and underscores the structural differences between these loan categories.

• 2009 - Financial Crisis:

  • During the financial crisis, non-sponsored leveraged loans saw a significantly higher default rate (15.04%) compared to sponsored leveraged loans (7.26%).

  • The lower default rate for sponsored loans highlights the resilience provided by private equity sponsorship during economic downturns. Private equity-backed firms often receive support from sponsors in challenging times, which helps prevent default.

• 2020 - COVID-19 Pandemic:

  • In 2020, default rates for both loan types were notably lower than in 2009. Sponsored loans had a default rate of 3.58%, while non-sponsored loans had a default rate of 10.14%.

  • The smaller gap between the two types in 2020 indicates that both types of loans were better managed during the pandemic. However, private equity-backed companies still exhibited greater stability, likely due to strategic oversight and financial assistance from sponsors.

• 2023 - Recent Data:

  • By 2023, default rates further declined for both sponsored and non-sponsored loans, with sponsored loans at 2.30% and non-sponsored loans at 7.84%.

  • This reduction suggests that both loan categories have benefited from improved underwriting standards and stronger economic recovery post-pandemic. Nevertheless, sponsored loans maintain a substantially lower default rate, reaffirming the role of private equity sponsorship in mitigating risk.

Private Credit Fund Investment by entity

The following chart displays the distribution of investments in private credit funds by different types of investors. This segmentation provides insight into the primary sources of capital for private credit, which is a key financing method outside traditional banks. Understanding the composition of these investors helps highlight the appeal and stability of private credit as an asset class across various types of institutions.

The investment base for private credit funds is highly diversified, with notable contributions from pension funds, insurance companies, and various other investors. The substantial share of "Unknown" investors also suggests growing interest from a range of undisclosed or emerging sources, highlighting the appeal and flexibility of private credit as an asset class.

• Unknown (35%): The largest share of private credit investment, at 35%, is classified as "Unknown." This category likely includes private or unclassified entities that prefer not to disclose their identities, or new and emerging sources. This substantial portion of anonymous investment could reflect the growing interest in private credit from a range of undisclosed institutional investors.

• Public Pension Funds (19%): Public pension funds represent the second-largest category, accounting for 19% of investments. This indicates a strong interest from public-sector retirement funds, which seek alternative assets like private credit for potentially higher yields to meet their long-term liabilities.

• Other (30%): This category encompasses a broad array of investors, including smaller institutions, private wealth funds, and perhaps family offices. At 30%, it underscores the diversity in private credit fund investors and suggests that a wide variety of institutions are drawn to the asset class.

• Insurance Companies (12%): Insurance companies contribute 12% of private credit fund investments. The relatively lower allocation may be due to the insurance industry’s need for liquidity and highly regulated asset allocations, but the presence of this sector also highlights private credit's appeal as a stable income-generating investment.

• Private Pension Funds (4%): Private pension funds make up the smallest identified segment at 4%. This lower share could indicate a cautious approach by private pension funds, which may have more stringent risk and regulatory considerations than public pension funds.

Conclusion

The private credit market has shown remarkable resilience and growth, reaching $2.1 trillion in 2023 with an impressive 15% compound annual growth rate over the past decade. This expansion reflects a robust demand for alternative financing solutions that provide flexibility, higher yields, and appeal to a wide range of investors, from public pension funds to insurance companies. With significant "dry powder" reserves, the sector is well-positioned to capitalize on emerging opportunities, especially in the current high-interest-rate environment where traditional credit sources are tightening.

Private credit’s competitive risk-return profile, with relatively low average annual credit losses compared to high-yield bonds, adds to its attractiveness, drawing institutional and private investors seeking yield enhancement with managed risk exposure. The sector’s structure, dominated by secured loans and supported by a mix of intermediary fund types, provides stability while accommodating the needs of diverse corporate borrowers, particularly in sectors like software, healthcare, and industrial machinery.

Additionally, the data on loan default rates highlights the advantages of private equity sponsorship in reducing risk. Sponsored loans consistently exhibit lower default rates than their non-sponsored counterparts, underscoring the risk mitigation and resilience that private equity-backed borrowers gain from their sponsors' strategic oversight and capital support.

In summary, private credit presents both significant opportunities and potential risks. Its ability to adapt to market conditions, demonstrated by its growth and evolving investor base, suggests a positive outlook for the sector. However, the rising levels of undeployed capital and the substantial share of investment from unknown sources may present challenges in maintaining discipline and transparency. As the market matures, investors will need to balance the pursuit of high yields with a vigilant approach to risk management to sustain private credit's role as a stable and attractive asset class.