Uncertainty in the market is accelerating the replacement of traditional banks by alternative investment managers, and we expect that this will be the case for at least the next few quarters.
Following the slowdown in traditional bank lending experienced post the Covid pandemic, continued macroeconomic concerns exacerbated by the recent failures of Silicon Valley Bank (SVB), Signature Bank and Credit Suisse, have perpetuated their concerns. While this has created challenges for borrowers, it has meant new opportunities for private lenders who are well positioned to fill the void.
Banks are focused on diversifying and minimizing risk. Combined with current policies, and in preparation of expected further regulation, it has become increasingly difficult for traditional banks to lend to SMEs which are the engine of growth for the economy, and for which access to capital is vital. This leaves many borrowers displaced and in need of new lending partners.
SVB and Signature Bank managed an oversized portion of venture debt and lending to earlier stage companies. Their relationship networks and market leading positions precluded many private firms and funds from permeating the space in a meaningful way. We believe the lending gap left in their wake will continue to benefit nonbank lenders.
Private credit lending continues to trend upwards well into 2023, while bank lending decreases. According to PitchBook, in 2022, investors lent an estimated $200 billion in private credit, compared to $156 billion in the year prior, but institutional leveraged-loan issuance fell by 63% and high-yield bond issues by 78% in the same time frame.
Companies are understandably looking to partner with well-established non-bank lenders, including private credit platforms, that do not face the same vulnerabilities and restrictions as niche or regional banks. Though borrowing through non-bank lenders has historically been more expensive, and so not necessarily a first port-of-call, many businesses require rapid and certain support, which means alternative options are becoming increasingly popular and necessary. They also offer more certainty than a traditional syndicated deal.
As the market stands today, there is significant opportunity to lend money or purchase debt compared to years past, and with traditional banks retrenching, forced to limit their scope of lending, the opportunities for nonbank lenders are substantial.
As balance sheets tighten and become more expensive, and with refinancings few and far between, investing in debt is increasingly more attractive. Returns for a given level of risk has doubled year over year through wider spreads and much higher short term interest rates. Preqin, which tracks alternative assets, expects that private credit assets under management will add almost another trillion dollars in the next five years to $2.3 trillion. The growing absence of traditional bank support has tightened access to venture capital across the board, and with additional demand on its dry powder, private credit firms can be even more selective about their investments – from what companies to what rates, as well as what kind of financing. There has been a growth in scope for private credit away from traditional sponsor finance across many areas. Notably, the recent bank failures mark the latest event accelerating opportunities for the net asset value (NAV) financing space. Traditional NAV financing has been around for quite a while but has grown a lot over the last few years as GPs are using it a lot more frequently and in different ways.
In 2022, NAV financing was particularly attractive, especially as it proved difficult for firms to exit investments at attractive valuations and provide much needed liquidity to their investors. Today, when the market is arguably more challenging than it was last year, we can only anticipate that demand for NAV financing will continue to increase as the industry works to stabilize and exits remain difficult. The combination of higher rates, slowing growth, economic uncertainty and a slower fundraising environment has contributed to this trend.
As firms navigate the current landscape, NAV financing will be instrumental in helping hold assets longer, free up dry powder to make new investments, and bridge to longer fundraising cycles.
There is also an increasing trend in scope for private lenders to provide creative capital solutions to sponsor backed companies. This can come in the form of asset-based lending, incremental loans alongside existing syndicates, factoring, loans against unencumbered collateral, amongst other types of lending. The tougher economic climate and the challenged exit environment will make these types of loans increasingly sought after and those private lenders who have flexible capital and mandates will fill the void left by traditional banks.
The trend of alternative asset managers capturing share that has been prevalent for over a decade seems poised to continue. Rising rates, lack of additional sources of financing, and a growing comfort level around using non-banks has positioned the industry to grow and gain relevance going forward.