1.2 How the market grew

Private credit was not invented after 2008. Specialist lenders, mezzanine funds and business development companies had been lending to mid-sized companies for decades. But the market was small, and banks did most of this lending. Over the past fifteen years that changed. Industry estimates put global private credit assets at roughly $1.5–2 trillion by 2024, several times the size of the market in 2010.

Knowing why it grew helps you understand how the market works today. It explains who the borrowers are, why they pay what they pay, and why investors keep adding money. This lesson tells that story in three parts: banks stepped back, investors went looking for yield, and non-bank lenders grew to fill the gap.

Before 2008: banks as lenders to the middle market

The middle market is the broad group of companies too big to be small businesses but too small to borrow easily in the public bond or syndicated loan markets. There is no single official definition, and different lenders draw the lines differently.

Before the 2008 financial crisis, banks were the main lenders to these companies. A bank would lend to a mid-sized manufacturer or a private equity-owned services firm and often keep that loan on its own balance sheet. The bank earned interest on the loan and also sold the borrower other services, such as cash management and payments.

Leveraged loans were a large part of this business. A leveraged loan is a loan to a company that already has a lot of debt compared with its earnings. Lenders usually measure this with EBITDA, which stands for earnings before interest, taxes, depreciation and amortization. It is a rough measure of the cash profit a business generates from operations. A company with total debt of 5x EBITDA owes five times its annual EBITDA.

After 2008: banks pull back

The 2008 financial crisis showed that many banks held too little capital against the risks they were taking. Regulators responded with new rules. Three matter most for private credit.

• Basel III. This is a set of international banking standards agreed after the crisis and phased in over the following years. It raised the amount of capital banks must hold against their assets, and added new liquidity requirements so banks keep more cash and easy-to-sell assets. For a bank, holding a risky, hard-to-sell loan to a mid-sized company became more expensive.
• The Dodd-Frank Act (2010). This US law greatly increased the regulation and supervision of US banks, including stress tests of how large banks would cope with a severe downturn.
• The Interagency Guidance on Leveraged Lending (2013). In March 2013, the three main US bank regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation) issued guidance on leveraged loans. Among other points, it said that total debt above about 6x EBITDA raised concerns for most industries. Banks became much more cautious about highly leveraged deals.

None of these rules banned banks from lending. Instead, they made some kinds of lending less attractive. Banks shifted toward larger, lower-risk borrowers, and toward arranging loans and selling them on rather than holding them. Holding loans to mid-sized, highly leveraged companies became less appealing.

Crucially, these rules applied to regulated banks, not to investment funds. A direct lending fund that raised money from pensions and insurers could make the same loan without the same capital charges or leverage guidance. That opened a door.

Investors looking for yield

At the same time, investors had a problem. After the crisis, central banks cut interest rates to near zero and kept them low for most of the 2010s. Yields on government bonds and high-quality corporate bonds fell sharply.

Many investors need steady income. Pension funds must pay retirees. Insurance companies must pay claims and policyholders. With safe bonds paying so little, they went looking for yield, meaning the income an investment pays as a percentage of its price.

Private loans offered an attractive answer:

• Higher interest than public bonds of similar credit quality, partly as payment for giving up liquidity.
• Floating rates, so income would rise if interest rates rose.
• Seniority and security, since many direct loans are first in line for repayment and backed by the borrower's assets.
• Less day-to-day price movement, because the loans do not trade and are valued periodically. (Lesson 4.2 explains why this can understate the true risk.)

Non-bank lenders fill the gap

Asset managers saw the opportunity. They raised dedicated direct lending funds, grew business development companies, and built teams to find and underwrite borrowers. Private equity firms, which were buying more mid-sized companies, welcomed lenders that could move fast and hold a whole loan.

The market kept growing through the 2010s. It then expanded into bigger deals. During periods of market stress, such as 2022, banks became reluctant to underwrite large syndicated loans. Private lenders stepped in to finance larger buyouts that once would have gone to the syndicated market. Today private credit competes with the public markets for many deals, not only small ones.

Rising interest rates in 2022 and 2023 also helped. Because private loans are floating rate, their income rose as rates went up, which attracted more investors.

A note on base rates: floating-rate loans used to be priced off the London Interbank Offered Rate (LIBOR). USD LIBOR ceased in June 2023. US loans are now priced off SOFR, the Secured Overnight Financing Rate. You may still see LIBOR in older documents.

Europe followed a similar path. European banks also faced tighter post-crisis rules and pulled back from mid-market lending, and direct lending funds grew to fill the space. The European market is smaller than the US market, and banks still play a larger role there.

An example

The following example is illustrative.

In 2006, Harlow Foods, a family-owned food distributor, borrowed from its regional bank. The bank held the loan and knew the family well.

In 2016, a private equity firm bought Harlow and wanted to fund the deal with debt of about 6.5x EBITDA. The regional bank, now wary of highly leveraged loans under its regulators' guidance, offered less. A direct lending fund, not subject to that guidance, provided the full amount at a higher spread. Harlow's owners paid more, but they got the deal done on the terms they needed.

Key terms

• Middle market: Mid-sized companies, too large to be small businesses but too small to borrow easily in public markets. Definitions vary.
• Leveraged loan: A loan to a company that already carries a lot of debt relative to its earnings.
• EBITDA: Earnings before interest, taxes, depreciation and amortization; a rough measure of operating cash profit.
• Basel III: International post-crisis banking standards that raised capital and liquidity requirements.
• Dodd-Frank Act: A 2010 US law that increased regulation and supervision of banks.
• Interagency Guidance on Leveraged Lending: 2013 US bank regulators' guidance discouraging banks from making highly leveraged loans.
• Yield: The income an investment pays, as a percentage of its price.
• SOFR: The Secured Overnight Financing Rate, the US base rate that replaced USD LIBOR.

Key takeaways

• Private credit existed before 2008, but banks did most middle-market lending.
• Post-crisis rules made it costlier for banks to hold risky loans to mid-sized companies.
• Those rules applied to banks, not to funds, so non-bank lenders filled the gap.
• Low rates in the 2010s pushed investors toward higher-yielding private loans.
• The market has since grown into larger deals and now competes with the public markets.