Private credit has a problem: Too much money

Mint

22-05-2025

Managers of private-lending funds have no shortage of money at their disposal. The question is whether they will have enough good places to put it.
During other recent bouts of volatility and uncertainty, private-credit managers of direct-lending funds—who raise money from investors to lend to relatively risky companies—have seen surges of activity and returns. Following the Covid-19 pandemic, direct-lending activity and investment returns both soared.
So President Trump's 'Liberation Day" trade policies, and the aftershocks and uncertainty for many companies in their wake, seem like they should herald another big moment for private credit.
This time around, however, there are some crucial differences. For one, this period of volatility is coming on the heels of a surge in private-credit fundraising. Traditional asset managers, banks and alternative-asset managers have all launched direct-lending vehicles, expanded partnerships and sought more retail funding.
At the same time, appetite from borrowers has been more limited than hoped for. This likely means that returns for investors, including the retail savers being courted by the private-credit industry, will be lower for some funds.
One big generator of higher-yielding loans is the private-equity industry, which requires a lot of borrowing to fund leverage buyouts. But economic uncertainty has put a damper on new deals, and the private-equity industry may be in even rougher shape than just that: Private-equity funds have been holding on to past investments longer, drying up cash flow back to investors in those funds. This hinders the deployment of funds for new deals.
'The industry has been beating the drum on M&A returning partly to justify the amount of capital they've raised," Josh Easterly, co-chief investment officer of alternative-asset manager Sixth Street, told analysts earlier this month on the earnings call for the firm's publicly traded business-development company Sixth Street Specialty Lending. 'The problem is that people paid too much for assets between 2019 and 2022, and nobody wants to sell those assets without an acceptable return."
This dynamic may also lead to lower yields on any new deals that do emerge, as lenders will be competing with each other on pricing.
'What you're seeing is an imbalance between supply and demand," says Marina Lukatsky, global head of research for credit and U.S. private equity at PitchBook LCD. 'When you see lenders competing for deals, that puts pressure on spreads." Spread refers to the additional yield on riskier loans over base rates.
Consider an estimate of the future performance of business-development companies. These are listed funds that raise public equity to invest in private loans. Back in 2021, the average BDC's annualized return on equity was 14.9%, according to figures from a recent letter by Easterly to shareholders of Sixth Street Specialty Lending. But in the letter, Easterly estimated that at the level of base rates expected by the market over three years, plus typical spreads for loans in the fourth quarter of 2024, the forward return on equity for a BDC would be 5.2%.
'At these spreads, the sector is not earning its…cost of equity," he wrote.
All of this helps explain why the biggest private-credit managers, such as Apollo Global, Ares Management, Blue Owl and Sixth Street, have put such an emphasis on originating new and proprietary kinds of loans, ranging from finding niches of consumer borrowing to multifaceted projects such as data centers.
Sixth Street's Easterly described it as 'more opportunity for complexity," and in particular lending to companies beyond those controlled by private-equity firms. Sixth Street Specialty Lending recently highlighted what executives called a 'bespoke" financing for a founder-owned rail and trucking software company, Bourque Logistics, at a weighted average yield of 13.9%.
Another advantage may accrue to managers that can combat the pressure on spreads on assets with lower funding-liability costs.
Apollo's chief executive, Marc Rowan, has often spoken of the dangers of too much capital without enough opportunity. Apollo's executives had also recently noted the unusually tight spreads earlier this year.
Yet the firm still opted to pursue inflows in the first quarter in the form of record issuance of so-called funding-agreement-backed notes to institutions via its Athene retirement-services unit. Essentially, Apollo decided that if money was coming cheap, it might as well tap that side of the market for now. That could boost future returns, even if spreads don't significantly widen.
'We were able to access cheap spread liabilities," but 'we didn't think it was appropriate to invest in tight spread assets at the same time," Apollo Chief Financial Officer Martin Kelly told analysts at a Barclays conference earlier this month.
Athene now has about $20 billion of cash and liquid assets waiting to be deployed, Kelly said. 'We'll put that to work as conditions come in, as we think is appropriate," he said.
If even the managers at the top of the heap expect to have to wait for the best pricing opportunities to come along, others may be waiting even longer.
Write to Telis Demos at [e-mail]