Private credit has become a more popular financing option across many industries and types of businesses—and the opportunity for investors to deploy this approach is growing. In this episode of Deal Volume, McKinsey’s podcast on private markets, McKinsey partner and host Brian Vickery speaks to Vivek Mathew, president and head of asset management at Antares Capital, one of the world’s largest private credit managers. They discuss how the private credit landscape has evolved, how the current market has affected or introduced opportunities for investors, and what trends investors should be aware of in the future.
How private credit has gained in popularity
Brian Vickery: Let’s start by talking about the excitement we’re seeing in private credit and where it’s coming from. The narrative about private credit for the past several years has been overwhelmingly positive, though the recent environment might be a little bit different. More broadly, we’ve seen record fundraising, great performance, and a lot of growth in the space.
Private financing has been around for a while, yet the amount of money flowing has substantially accelerated. Our research shows that LPs still cannot get their hands on enough private credit and remain substantially underallocated to the asset class. So why are we seeing all the excitement?
Vivek Mathew: We don’t believe that this age is necessarily better than other ages in the industry. There are a lot of new players in private credit and a lot of new people raising capital. [Antares has] been around for almost 30 years. We started the company back then for the same reasons why private financing is attractive today. There is a premium for liquidity. There’s an opportunity to lend to fantastic companies that are owned by private equity sponsors. You can get access to a lot of research and information [for investment opportunities]. There are many reasons why [private financing] is a fantastic asset class, and I think other companies have realized that, too.
I do think we are in a bit of a “Goldilocks zone,” where rates have been high enough that we can lend and make a decent amount of money, but they aren’t high enough to have caused widespread issues. Now, the consensus is that we may be moving into a soft landing. If rates come down a little bit because we have a handle on inflation, then we feel that the M&A market will pick up. The most important thing to the success of a private credit lender is the backdrop of the US economy. If the economy is in a healthy place, then rates will come down and extend the Goldilocks period.
Brian Vickery: You mentioned that this Goldilocks period is not necessarily different than the cycles you’ve seen in the past, but there’s certainly more capital that has to be coming from somewhere, whether it’s from pensions, sovereigns, endowments, or private money. What is changing in the LP landscape?
Vivek Mathew: Investors across the globe are more in the accumulation phase. In private credit, we haven’t reached a saturation point. For example, in Japan, though rates have come up a little bit, the environment is consistently low rate, and they’re looking to continued external investment from private credit. As another example, in South Korea and the Middle East, we’ve tried to educate investors to help them diversify and increase alternative investments. In those two regions, alternative investments for many years mostly meant private equity and real estate. Now, we’re educating them about private credit as another potential option. In the case of the Middle East, they’ve made a lot of money on energy recently, and they’re looking to further diversify that. So there’s more capital coming from that region.
In the United States, most investors have some exposure to private credit, but perhaps not enough. Take an insurance company: the strategic asset allocation to private credit but, given the industry’s capital benefits, the credit exposure is probably too low. So they’re considering how to create a more diversified portfolio of private credit so that they’re not doubling down on the same types of risk.
The total addressable market for private capital and how it has evolved
Brian Vickery: In terms of the money that’s coming into the space relative to the opportunity available, how should investors think about the addressable market?
Vivek Mathew: The total addressable market or the total opportunity to lend is growing faster than the capital that is flowing in. Spreads over the past six to eight years—when money started flowing into this space—are a little bit tighter today than they were before. When asset classes are not in equilibrium, and demand outweighs supply, markets are efficient and spreads tighten quickly. Right now, spreads are tightening because the local supply of M&A is lower than the demand.
Zooming out, the total addressable market looks attractive. Private equity has raised a lot of capital. So even though spreads are tightening, the market opportunity could increase quicker than the capital is coming in. Just because private equity has raised the money, we want to make sure they spend it responsibly. If they’re struggling to find opportunities and have to sacrifice quality, then that will lead to more defaults and worse credit outcomes for us and our investors.
We spent a lot of time looking at the penetration rate of private equity and seeing how many middle-market companies are owned by private equity—that number is only about 15 percent. It doesn’t feel like anyone’s stretching. That gives us confidence that the quality of our investments can remain high.
Brian Vickery: The market is growing and ought to grow quickly at some point in the future. Over the past 18 months, deal volume has been meaningfully slower than it has been in the past. You’re close to the tip of the spear and seeing the deal flow that’s coming across as Antares is financing companies. How are you seeing the current market evolve over the next several months?
Vivek Mathew: It’s no secret that the M&A market has been slow: risk premiums went up, and there was a concern with inflation. We have seen a real increase in the pipeline recently, so we’re hopeful that M&A will pick up. Still, when a quality asset comes to market from a lending perspective, there’s a lot of competition.
The stock market is performing great, so private equity firms are waiting to sell companies to catch rate breaks or grow the EBITDA of the business to have a higher valuation. The additional dynamic that we’ve observed is LPs interested in return of capital. If sponsors are interested in raising their next fund, there is some return of capital that existing investors may expect to receive, which may catalyze more M&A. Of course, lower rates would be helpful.
Brian Vickery: When I started my career as an LP, we weren’t talking about DPI [distributions to paid in capital ratio] as a metric. In the current environment, it seems as if everybody is worried about DPI as opposed to total return.
Vivek Mathew: Once the market picks up, private equity firms don’t necessarily want to be the first ones to [try to make returns on their investments], but they also don’t want to be the last ones selling similar businesses to somebody else. That’s why we think that when the market picks up, given the amount of capital that’s been raised, there could be a real deluge of M&A for a lengthy period.
Managing current market conditions and risks in portfolios
Brian Vickery: You talked about private equity marks and how some of those marks are high enough that firms might be able to sell an asset today. How does that translate into your portfolio or your competitors’ portfolios? Several years ago, we weren’t worried about the private-lending portfolios and the capital that had been put out. More people are concerned about the risk embedded in those portfolios today. How should they approach that concern?
Vivek Mathew: The risk in our portfolio has been manageable because the US economy has been resilient, and our portfolio has exceeded expectations. In the past several quarters, though growth has been slowing, revenue and EBITDA growth have been positive. A year ago, we weren’t expecting positive growth overall across our portfolio. Certain sectors are more challenged—many of them were greatly affected by COVID-19, such as aerospace, some consumer sectors, and some subsectors of healthcare. But these are fairly niche parts of our portfolio.
Right now, we’re focused on liquidity with higher rates, and we spend a lot of time trying to understand the situation of a portfolio company. We understand when they’re drawing money and what they’re using it for. Revolver draw is something that often is an early indicator of risk. We do think that losses are going to be higher in 2024 and 2025 than they have been. So there will be more opportunities to restructure, and having those capabilities and resources to do so will be important.
When we think about peak losses that we’ve seen in the industry, in the 2008–09 period, we saw about a 1 percent loss, which is worse than now by a long shot. Just because losses in the near future may be higher than they have been doesn’t mean it’s not a good time to invest. In fact, we think this could be one of our best vintages, even if losses go up a little bit.
Brian Vickery: How do you think about the operations and the workout potential of an environment in which there are more losses? Are you and your peers positioned to be able to recover in that environment? If we do see more distress, you might anticipate it, even if you don’t reach peak levels.
Vivek Mathew: There’s a real differentiation in the market among companies that spend a lot of time, energy, and resources on preparing for possible losses. Because there are a lot of newer entrants in the market, most of them have not invested heavily in stressed environments. But having these capabilities provides a lot of value for investors.
Underwriting is going to matter more. Firms should consider if they’re picking a company that has reason to exist and is a market leader. There’s a real skill to having conversations once something goes wrong and having the capability to take over the company. That’s never the goal, but it’s important to have those capabilities if necessary.
In the latest cycle, there was a fair amount of stressed and distressed raised capital that was returned. I think the market will be able to absorb those potential opportunities, but the beneficiaries of those opportunities may be different firms from those that originated the assets because the original firms don’t necessarily have these workout capabilities.
Brian Vickery: As rates come down, how has the environment today changed how you think about underwriting new deals?
Vivek Mathew: First, we’ve diversified our portfolio a lot [to protect against risk]; we lend to about 500 companies. Sometimes it takes more work as a direct lender to be so diversified because you have to manage how much capital you’re allocating to each asset. Diversity comes from not only the number of companies but also in the details of a company. So we also diversify sponsors, the kinds of industries we invest in, and the customer and supplier concentrations.
Because rates have risen, the interest coverage that we’re experiencing today is different than the interest coverage that we have experienced, and we also try to adapt to everything going on in the world [to protect against risk]. COVID-19 validated a lot of how we underwrite.
Approaching the competitive landscape and diversifying assets
Brian Vickery: Banks and syndicated channels have reemerged recently. How are you experiencing today’s competitive environment? How is it evolving?
Vivek Mathew: The total addressable market for private credit has grown. There are more opportunities for private equity, and the syndicated market has come into play as a potential option for private credit more than it has in the past. And there’s been a push and pull with that part of the market.
There was a time when BSLs [broadly syndicated loans] and capital markets weren’t functioning well. There was a negative outlook on the future of the economy, and inflation was a concern. Risk premiums caused by geopolitical events had gone up, and confidence in syndication was low. Private credit came in and filled that gap. There were opportunities to lend to larger companies that weren’t traditionally considered with direct lending.
Now, banks have worked through risk on their books, and the BSL market has been functioning well. When banks came back, they were eager to recoup some of the market share that was lost to direct lenders. There’s been a lot of refinancing—it’s not net new money, but it’s activity. I think moving forward, private credit will always be an option for the syndicated market, as well as the public option.
Brian Vickery: When it comes to broadening product capabilities, how could companies put money into other parts of the fixed-income spectrum, apart from the traditional ways?
Vivek Mathew: I think any business asset manager is always thinking about the obvious natural extensions of what they do, what capabilities they have, and what infrastructure they possess. A few things are likely to happen. One is that scale will become increasingly more important, just as it has in private credit. It will become harder for smaller managers to add value in the growing market as scale and access become more important. I think you’ll see some consolidation and M&A in direct traditional senior lending.
Second, some managers will expand geographically. For example, I could have a relationship with a sponsor in the United States that has a business in Europe. It makes sense for me to capture the additional wallet. I already have a firmwide relationship. If I get to know some different people, we both could do more with that relationship. Effectively, the total addressable market for any given party will grow.
Third, there is a lot of room for growth in the market for credit secondaries. Junior capital is a natural area in which to expand. Lenders like us have traditionally been focused on the senior side, and we possess the skills and access to expand that.
Last, we’ve only scratched the surface from a wealth and insurance perspective. Wealth is not a new access point for private credit, but alternatives allocations for an insurance company are probably substantially higher. There’s a lot of value that we and other direct lenders can add to a wealth investor’s portfolio. From our perspective, it makes sense to diversify our capital base.
Brian Vickery: What’s something you think may happen in the next few years that others maybe aren’t expecting?
Vivek Mathew: It’s been interesting to see how the rate of spread changes in the market. Spreads were steady and consistent for a long time. As M&A has slowed, the supply and demand dynamic has picked up, and spreads have tightened rapidly. I also think defaults will go up. I think investors will then focus even more on alignment. The traditional kind of capital-light asset investor might start looking at alignment and incentives differently as we see some change in the market.
