Alternative credit growth story paves way for wider take-up

Alternative credit is not a new phenomenon. However, up until the 2008 global financial crisis (GFC), it was largely overlooked by investors, confined primarily to a small group of asset classes. 

 

The market crash was a catalyst for alternative credit. Banks froze traditional lending options and limited those capabilities due to tighter regulations shortly after. Borrowers had to look elsewhere for financing, opening up the world of alternative credit. 

 

The GFC: sparking innovation

 

Alternative credit consists of asset classes that provide financing options outside of traditional fixed income markets. Investors were drawn to these investments in the wake of the GFC public markets started to face challenges – initially from the extreme volatility during the crisis and then due to shortfalls in adequate income amid the ensuing ultra-low interest rate environment.

 

While the GFC was the spark, alternative credit has flourished over the last 15 years based on much more than “right place, right time” sentiment. During this time, different asset classes have developed in this space through greater innovation, both in how loans are financed and how issuers are able to borrow. For investors, this trend has offered new opportunities across the risk/return spectrum.

 

 

In line with the necessity for borrowers to obtain financing and for investors to generate alternative income streams, direct lending initially fuelled the alternative credit market. 

 

However, a catalogue of asset classes now provide essential diversification for investors, and we are confident we will see a similar growth story across these investment options.

 

The alternative credit landscape in focus

 

• Direct lending: The market continues to see opportunities across senior and junior loans. The falling rate cycle in Europe and the US should provide ample scope for greater take-up.

 

• Collateralised loan obligations (CLOs): Higher-for-longer base rates support healthy relative yields across the CLO debt spectrum. On the equity side, the long-term, non-marked-to-market nature of CLOs complements the current market dynamics with CLO equity.

 

• Commercial real estate debt: Following a challenging period, the overall real estate market has undergone systemic shifts. Opportunities are appearing as borrowers return to this new-look market.

 

• Commercial Property Assessed Clean Energy (C-PACE): The green loan market continues to expand, while opportunities to support environmental construction and social issues support demand for the real estate financing instrument.

 

The continued case for direct landing

 

US: As we enter 2025, the US Federal Reserve appears to have pulled off a tricky balancing act – taking the heat out of inflation while also keeping the US economy running smoothly. Yet any further cuts are expected to materialise slowly through 2025 and we appear to have reached terminal rate levels. This should sustain the investor-friendly private debt terms – lower borrower leverage and higher yields.

 

With reference rates down by 100 basis points in 2024, companies have had some relief in the cost of capital and interest burden. With stabilised rates creating greater certainty around valuations, we expect to see a sustained and meaningful pick-up in merger and acquisition activity.

 

Private debt investors should benefit from higher all-in yields for longer, which, although lower than during peak rates, are still close to historic highs. Given that businesses have proven they can withstand and expand in the current rate environment, we see the potential for highly favourable risk-adjusted returns this year.

 

Investors’ focus could shift back to the fundamentals of company earnings as the shock of peak rates is now behind us and there seems to be greater certainty for the next 12 months. 

 

Europe: European direct lending has started 2025 with optimism. While some economies in the region may not be in growth mode, and the geopolitical situation remains a concern for the continent, we will likely be in a stagnant or low growth environment in the coming quarters.

 

Fortunately, direct lending has a focus on defensive, non-cyclical industries. Hence, it is not dependant on high levels of GDP growth. Slow and steady is sufficient for healthy portfolios and provides ample opportunity for deal activity as well.

 

Softening inflation will ease the burden on issuer earnings, and declining rates will ease pressure on cashflows. 

 

While rate cuts will eat into returns, the senior segment of loans remains an attractive position. This should make up for returns impacted by rate cuts through early  repayment fees, and the spreads of these loans.

 

Thoughtful portfolio positioning

 

Global market conditions today require an expert understanding of the direct lending environment in 2025. 

 

Underlying risks will not shift significantly, with expected default and loss rates being a focus point but likely to remain muted within our portfolio. 

 

Click here to read Nuveen’s latest Alternative Credit Insights for expert commentary on the developments across asset classes in private alternative credit. 

 

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