Direct Lending Can Deliver Strong Returns: AB

Despite potential central bank interest rate cuts, Matthew D. Bass, AllianceBernstein’s head of private alternatives, believes that direct lending will continue to deliver strong returns this year.

“Persistent stress among small and mid-sized banks who must comply with changing regulations and funding needs should broaden the investment opportunity set for private lenders and enhance return potential,” Bass said.

He noted that high interest rates cooled deal activity in direct lending last year, but with average yields above 12% in 2023, the strategy also generated strong returns for investors.

“Spreads on new deals have narrowed in early 2024. But we expect the base rate used to price direct corporate loans to finish 2024 around 4.5%, well above the sub-1% levels that prevailed for years after the global financial crisis,” Bass said. That will keep new-issue yields in private credit above historical levels, which should add up to high return potential for investors.”

Some borrowers will struggle with high interest rates, which will place a premium on a manager’s ability to create robust portfolios based on solid upfront underwriting, proper structure, and active portfolio management across existing positions. However, a more stable interest rate environment and narrowing bid-ask spreads should help boost overall deal activity, according to Bass.

“Higher-for-longer interest rates will create some hurdles. But the overall economic outlook is promising. Yields look set to stay well above their levels before the pandemic, while the market for private credit continues to grow at a fast clip. In our view, that’s good news for lenders and investors alike,” said Bass.