5 trends we expect to impact private credit in 2024

While 2023 was a very attractive investment hunting ground for our clients and funds, it also didn’t contain the level of economic dislocation we were expecting. However, 2024 may yet prove to be an even more opportune time to deploy capital. We have summarised where we believe you should watch for opportunities in the private credit space in 2024.

1. Unexpected resilience will become delayed dislocation

Australia dodged recession in 2023 and stress in the financial system was lower than expected. Consumers adjusted to the higher rate environment, thanks in part to employment levels staying steady (amidst the backdrop of population growth) and record highs of household savings to draw on. This in turn cushioned some of the impact on Australian businesses, most of which were comfortably leveraged giving them a buffer against market conditions.

Businesses adapted periodically to the challenges, implementing (short-term) initiatives and streamlining operations. Meanwhile, many providers of capital were lenient, giving some space to struggling businesses. While we’ve certainly seen a shift from borrowing for growth to borrowing to consolidate balance sheets and strengthen positions, Australian businesses and consumers found ways to ride out the year.

But, while inflation is beginning to fall slowly, it will be a hard road to the RBA's 2025 target of 3%, and we anticipate prolonged high interest rates over the next few years as well. Broadly, we expect the resilience of this year to continue into next, but many short-term tailwinds from 2023 will be unsustainable in the longer term – from financer patience to halting R&D or marketing and the growth impacts of deferring capex – and pockets of financial stress are likely to widen and volatility increase.

2. Traditional lenders will get more nervous, further drying up capital

As this stress and volatility ramp up, and geopolitical tensions drag on, traditional lenders – banks and credit funds – will further tighten their risk parameters in a binary manner, reflecting their risk appetite. 

As a result of diminished supply, companies and asset owners will find themselves further constrained to raise capital in the usual ways – borrowing from banks or raising equity in traditional markets – leading to market dislocation.

3. Gold sits undiscovered in the market

Consequently, these borrowers will look elsewhere for funding. As IPO markets remain largely closed, bankers and advisers recommend alternative borrowing structures to businesses. Many will find an answer in flexible private credit providers, better structured to apply more creative solutions to businesses’ borrowing needs. This will raise the quality of counterparties looking to access private credit, creating richer opportunities for investors.

Unlike most lenders, Keyview doesn’t focus on specific sectors – instead, we look opportunistically across the market – but we do expect particularly rich veins of opportunity in these sectors next year with strong risk-adjusted returns:

1. Real estate is particularly sensitive to interest rates and the sector is undergoing an adjustment cycle in response. We saw assets come under pressure from rising rates in 2023, increasing difficulties for developers to build new assets and stranded projects under construction with financiers losing patience or exhausting funding lines. Pockets of the market (e.g., residential) continue to be undersupplied however, so there are strong opportunities for private credit where owners of quality assets have become overextended and need liquidity to continue to operate successfully. Such instances can offer equity-like returns for investors and rescue stranded high-quality assets while still preserving investor capital from the recovery value of the asset. It’s a rare win-win-win situation: good news for businesses, good news for private credit investors, and good news for the economy and housing market.
2. We expect strong deal flow in financial services, particularly those that on-sell financing solutions as they are capital-hungry businesses; requiring ongoing capital to build operational scale while often able to recoup higher borrowing costs.
3. With continued uncertainty in global markets, we expect an influx of commodity-backed deals, especially at the smaller end of the market, because these are particularly hampered by funding shortages.

In mining, we have recently identified an opportunity that perfectly illustrates the value of sitting in the market for those with the capabilities to tap into it. A collection of gold mines (with long operating histories in a highly regarded gold basin) were abandoned by major global developers because they are small, non-core projects that are now too difficult for them to solve. Stockpiles of unprocessed gold were waiting to be made marketable (coupled with large, un-mined gold reserves) and all that was missing was an injection of capital, correctly applied with deep private credit expertise. The risk to investors remains very low as the existing stockpiles of gold can be reprocessed multiple times over to recover capital, without relying on the company to process newly mined gold reserves. The private credit market in 2024 will be like this across many sectors – with hidden gold waiting to be turned into strong returns.

4. M&A activity will surge

We expect mergers and acquisition activity to pick up significantly in the new year. This will be driven largely by growing market comfort around the 2023 valuation and cost of capital adjustments (particularly in sectors such as tech, real estate and industrials). We believe that private asset owners/sponsors (e.g., private equity and large family offices) have maintained large liquidity reserves to deploy towards acquisitions, at the right price. While these sponsors may be accustomed to turning to banks, in a constrained capital and risk-averse environment, private credit has a very active role to play in funding M&As. 

Traditional lenders usually have rigid criteria for investment, meaning any complexity or difference can push borrowers out. Alone, this doesn’t indicate a higher risk for borrowers – only that it is not suited to banks’ structures. But traditional lenders can also be too slow to help in a competitive M&A environment – that’s where nimble private creditors can step in.

5. Private Credit will experience a bumper year

In this phase of the market cycle, private credit is about to become a much bigger asset class in Australian portfolios. Private credit will grow its foothold in the Australian market as investors look for equity-like returns in a credit format – high and consistent yield for a less risky product – while banks pull back amidst elevated risk. There’s a strong demand for credit allocation and strong investor support as large institutional investors have begun looking at Australia as the next developed economy to expand into. 

Opportunistic credit, with its significantly lower exposure to market movements, will rule as general market volatility continues.

Greater dislocation creates a wider opportunity set with less competition for more complex situations – with the added tailwind of rising interest rates. Investors are looking at exceptional double-digit returns, as high as 20% over the next two to three years – opportunities that haven’t existed in this market for a long time, or that wholesale investors were unable to access previously.

At a systemic level, private credit opportunities will also grow longer term. In mature markets, banks/securities firms typically account for under 30% of the institutional leveraged loan market, while in Australia’s more nascent market, they still account for more than 80%. The next five to ten years will see a rebalancing in favour of private credit in line with global markets, as it addresses the high-value opportunities outside of banks’ fields of interest.

Making hay

Upcoming market dislocation will enable private credit investors, via the right managers, to capitalise on emerging opportunities. As banks re-evaluate their risk parameters, private credit stands to benefit from the influx of high-quality businesses seeking flexible financing solutions. Private credit will continue to emerge as a crucial and strategic player in Australia's economic landscape, poised to shape the investment landscape in the coming year.

If you are considering allocating to private credit in 2024, there are three factors as part of the formula for strong, risk-adjusted returns:

a) A catalyst that creates opportunity with strong underlying value;

b) An investment manager with the capabilities – resources, experience, speed, capacity for complexity – to structure, execute and manage the opportunity;

c) And, of course, capital – in particular, a creditor able and willing to deploy liquidity during a liquidity desert. Historically, this is where huge value can be created.

We look forward to continuing to support Australian businesses and create value for Australian investors in the year to come.

Find out more about Keyview here.

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