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Trends Watch: Private Credit Outlook

Sep 7, 2023

Trends Watch: Private Credit Outlook 

By Elana Margulies-Snyderman 

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Kate Moore, Managing Director and Chief Operating Officer, TortoiseEcofin.

What is your outlook for private credit?

Private credit has grown substantially over the past 10-15 years.  A significant catalyst for growth can largely be traced back to the shift following the Great Financial Crisis (“GFC”).  Prior to the GFC, banks dominated the private credit space.  However, following increased regulations and risk off measures from the banking sector, private credit has evolved to being synonymous with non-bank, alternative lenders.  During this period, we were living in a low interest rate environment with investors seeking higher yield, driving an increase in demand for private credit and the rise in demand for alternatives more broadly.

As a result, we have also seen cheap money chasing yield over the last decade or more.  This can lead to a misalignment between capital investment and the riskiness of the loans, creating a mispricing of risk in some cases, or worse, an unprincipled pricing of risk.  As interest rates have risen over the past ~15 months, there’s been a shift back to equilibrium.  As such, borrowers’ payments continue to increase and differentiation among managers will become evident; those with quality portfolios will stand out amongst the crowd.

Where do you see the greatest opportunities and why?

As interest rates increase, less capital is chasing yield and thus tilts negotiating power back in the hands of lenders, allowing more selectivity amongst loan issuances.  Furthermore, the swift pace of change in rate increases magnifies the rare opportunity for private credit managers with dry powder. So, the question becomes: Where within the private credit space is the right place to play?  We believe that while there is still macro uncertainty, with respect to inflation, geopolitical risk, supply chain constraints and a looming risk of recession, the real opportunity exists within infrastructure. 

Infrastructure loans, specifically project finance, is a subset of financing where debt is linked to projects rather than corporate entities.  These loans tend to offer strong collateral secured by the underlying infrastructure assets and more protective covenants than traditional corporate debt, and generally require specialized expertise.  Access to these limited middle-market opportunities provides a diversification opportunity in portfolios that can result in lower correlation to broad market events, dampening volatility within a portfolio. 

At Ecofin, we believe there’s a compelling opportunity for infrastructure investments in growing markets supported by strong secular tailwinds such as essential services focused on affordable education, health care and housing and waste transition.

Education: Public sentiment toward school choice and non-traditional options is growing, especially for those in impoverished communities.  This was amplified during and following the COVID pandemic with 78% of parents saying they became more involved because of what they saw of their children’s education during the pandemic.

Health Care and Housing: The U.S. population is aging rapidly, with the senior population projected to double by 2037, but the rising cost of assisted living has become unaffordable for low- and even middle-income seniors.  There are fewer units under construction, exasperating the unbalanced supply and demand issue in the years to come.

Waste Transition: We expect sustainable project finance will continue to rapidly evolve and grow.  We are undergoing a significant environmental transformation to achieve a net-zero carbon future and at the heart of this is a more circular economy.  Circular economy efforts target a reduction in single-use waste and promote recycling and reuse. Growth prospects in the U.S. waste-to-energy sector are strong given the large number of projects recently completed, in construction or planned. In addition, there is a relatively low implementation rate in the U.S. for waste-to-energy compared to other industrialized nations.

What are the greatest challenges you face and why?

Before answering this question, it’s important to understand the areas in which Ecofin specializes.  We are a specialized investment manager providing growth capital in the form of debt for lower middle-market infrastructure projects.  Many of our loans are related to private nonprofits, 501(c)(3) organizations and other entities authorized to issue private activity and tax-exempt municipal bonds.  Based on the areas in which we specialize, we’ve seen three primary challenges:

First, following the recent increase in interest rates, we have generally seen an interest rate cap on high yield loans, meaning we cannot increase rates in lockstep with treasuries as it can become challenging for the borrower. 

Second, because the majority of our loans are federally tax-exempt, this results in a higher tax equivalent yield.  While this is certainly additive for our investors, it’s imperative that we provide ample education on this topic.  Investors need to assume they will be in a high tax bracket for the duration of the loans and, likewise, need to compare consistent metrics across loan portfolios and investment managers.

Lastly, we have what we’d call perception risk.  Risk that smaller or boutique asset managers aren’t as skilled as large asset gathers.  However, returns don’t prove that out.  But when you see a brand name asset manager in the media often, it is difficult for smaller asset managers to compete.

What keeps you up at night? 

As a smaller manager, we have to perform better than our competition to gain attention.  Even then, the preferences of the game are changing.  Metrics such as fund size, length of track record, firm assets under management (AUM), etc. are all requirements of an allocator’s due diligence, and all of those numbers are continually increasing.  Furthermore, we continue to see consolidation in the industry, only upping the ante.   Despite this, we continue to be bullish on the sector and believe our smaller size allows us to be nimble and differentiated and adapt more quickly to changing market conditions.

 The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.


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Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.

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