Tim Thran currently serves as managing director, associate portfolio manager at Bluerock, a leading alternative asset manager.
Russ Alan Prince: What factors contribute to the growing opportunity in private credit markets, and what is your outlook?
Tim Thran: Private, or alternative, credit is in the midst of an explosive growth stage, a trend which we believe is just getting started, as debt availability from traditional sources has pulled back materially post-pandemic, leaving an opportunistic void for well-capitalized participants to fill in both corporate and real estate credit markets. Business demand for credit remains robust, and capital providers and investor interest in search of higher risk-adjusted yields is driving the alternative credit market’s growth.
While interest rates from non-bank lending sources tend to be higher than conventional bank loans, they offer numerous advantages for borrowers, including flexibility in terms, certainty of execution and non-recourse financing. Private credit, in turn, offers investors something that is difficult to find elsewhere: high current income, often in a senior position to other lenders. A potential wave of coming loan maturities in the high-yield market may also provide attractive lending opportunities. We are not alone in this outlook, as one major recent projection called for the global private debt market to roughly double to $3.5 trillion by 2028. Because of these structural changes in lending, our private credit outlook is favorable.
Prince: How do macroeconomic trends impact the attractiveness of private credit?
Thran: We believe an environment of elevated interest rates will prevail for the next several years, and the days of ultra-low rates driven by monetary policy are behind us. Higher rates are likely to remain due to the waning of post-GFC era structural deflationary forces, highlighting a renewed emphasis on the benefits of current yield, in contrast to long-duration, risk assets such as equities.
Currently, the extremely narrow equity risk premiums, coupled with moderating earnings growth expectations in equity markets, should continue to favor relative opportunities in credit. As of December 2023, U.S. BBB corporate bond yields were 120 basis points above the S&P 500 earnings yield, meaning that corporate credit offered both a greater yield versus equity and also more investor protection, given debt is higher in the corporate capital structure relative to equity). We believe investors’ performance over the next market cycle will be buoyed by including a dedicated credit allocation.
Prince: What emerging sectors within private credit does Bluerock see presenting opportunities for investors?
Thran: Our highest conviction themes within the broad realm of private credit are senior secured loans (SSLs), collateralized loan obligations (CLOs) and private real estate credit. SSLs provide valuable financing to companies for their operating needs and, as the name implies, are senior to all other financing and are secured by a company’s assets, including cash and receivables. We see attractive opportunities in the SSL market, given the depth of the market (>$1.4 trillion in size) and its 30-year multi-cycle track record of historically low loss rates (~1%). SSLs are also floating rate instruments, which hedge against interest rate risk and carry an attractive yield premium above risk-free rates. The low loss rates combined with attractive yields present asymmetric risk/return opportunities for credit-focused investment managers to drive total return. In particular, we prefer broadly syndicated loans—issued to larger market capitalization corporations—over the smaller, middle market category, which are typically less liquid and less transparent to the market.
CLOs are a structure that invests in diversified pools of SSLs, often 200 to 300 senior loans. We believe the CLO “wrapper” optimizes the benefits of SSLs in a structure that creates tiers for investors suited for various yield and risk levels. CLOs offer non-recourse, long-term financing, allowing savvy managers to optimize risk-adjusted returns for investors, particularly during periods of market disruption. We see the highest long-term potential in equity tranches, where distribution rates have averaged nearly 15% in the last 20 years.
We also believe private real estate credit is poised to outperform, with significant market expansion for many of the same reasons as corporate credit: constrained bank lending, structurally higher interest rates and competitive returns versus real estate equity, but with higher positioning in the real estate capital stack. The recent real estate valuation declines have presented an attractive opportunity for new capital to fill the void of regional banks and traditional lenders. The near-term loan maturities may be more of a “wave” rather than a “wall,” with approximately $2.2 trillion worth of commercial real estate loans maturing through 2028. This presents a multi-year investment opportunity as opposed to a one-time event. Further, as commercial banks pull back on real estate lending and the CMBS market remains constrained, credit opportunities will expand across the real estate market, including senior loans, interim loans, mezzanine and development financing. Our highest conviction themes in real estate lending remain in asset types with strong fundamental demand drivers, such as industrial and residential.
Russ Alan Prince is a strategist for family offices and the ultra-wealthy. He has co-authored 70 books in the field, including Making Smart Decisions: How Ultra-Wealthy Families Get Superior Wealth Planning Results.