Reed Smith LLP recently hosted a Fund Finance Association NextGen event in New York. The event featured a panel discussion with representatives from various fund finance market participants. 

Panelists discussed growing trends in private credit and the challenges that the industry is facing. In this article, we will highlight key insights shared by the panelists.

Direct Lending and the Rise of Upper Middle Market and Corporate Lending

Financial markets are rapidly changing, which has led to significant changes in the realm of private credit. One significant trend in the private credit space is the increasing focus on direct lending, particularly in the upper middle market and corporate lending sectors. With traditional banks scaling back, private credit funds have stepped in to fill the void, providing financing solutions to funds in need.

Exploring the Potential of Private Credit

Investors recognize the advantages of private credit and are increasingly allocating their capital to this asset class. Private credit has shown resilience and outperformance compared to other asset classes. This trend is driven by factors such as the Limited Partners (LPs) denominator effect, which has slowed down the public markets, prompting investors to seek alternative sources of returns.

Addressing Challenges in the Absence of an Exit Market

Unlike private equity, private credit often lacks a vibrant exit market. In this scenario, investors and deal participants explore alternative strategies such as add-on investments and other opportunities within the portfolio. This approach allows for continued growth and the potential for enhanced returns.

Feeder Funds: Expanding Opportunities and Exposure

Originally designed to cater to insurance capital, feeder funds have become a popular tool for LPs seeking credit exposure. Furthermore, the expansion of technology within private credit has allowed for the application of strategies initially used by general partners (GPs) to areas like warehouse lending, fund finance, infrastructure, and more.

Pain Points for LPs Considering New Allocations

LPs face several challenges when contemplating new allocations, including uncertain PE valuations, the effects of the economic fallout from Federal interest rate hikes, and a need  to better understand net asset value (NAV) facilities as an alternative to traditional capital commitment facilities.

Pain Points for Lenders and Deal Participants 

Deal participants and lenders face challenges of their own, including reduced balance sheet availability at banks, the exit of major players from the subscription line business, and increased competition from hedge funds, insurance companies, private credit funds and sophisticated family offices.

Key topics under consideration include valuation issues, the need for more collateral while lending selectively, and the implementation of more aggressive covenants.

Conclusion

As the landscape of private credit continues to evolve, investors and deal participants must adapt to the changing dynamics. By understanding the trends, challenges, and opportunities of the private credit market and alternative financing structures, investors can make well-informed decisions and navigate this dynamic market successfully. Embracing change and staying knowledgeable will be key to thriving in the ever-evolving world of private credit.