The next era of private credit

McKinsey & Company argues that private credit, one of the fastest-growing segments of the financial system over the past 15 years, is entering a new era defined by a broader asset base, new ecosystem partnerships, scale advantages, and greater technology use. The asset class, as commonly measured, totaled nearly $2 trillion by the end of 2023. Growth to date has been concentrated in direct lending, driven by banks' retreat from leveraged lending and the rapid expansion of private equity. Amid higher rates and a slower PE deal environment, private credit has begun extending into asset-based financing structures.

The sources of capital seeking private credit exposure are diversifying, with significant inflows from retail and insurance capital pools. The competitive landscape has grown more crowded, with insurers, traditional asset managers and banks increasing their direct participation. McKinsey sees a potential accelerated transition of assets from bank balance sheets to nonbank entities, driven by regulatory changes and nonbank competition. The firm characterizes this as a generational opportunity for private credit funds, asset managers and insurers able to establish reliable origination, and as a strategic inflection point for banks.

McKinsey expects four asset classes to increasingly shift to nonbank lenders: asset-backed finance, such as aircraft loans and equipment leasing; long-duration infrastructure and project finance assets of five years or more; jumbo residential mortgages with high loan-to-value ratios or nonconforming classifications; and higher-risk commercial real estate. The firm projects that $5 trillion to $6 trillion of such assets could move into the US nonbank ecosystem over the next decade, provided interest rates stay elevated, asset performance remains within historical ranges, and the current bank regulatory regime persists.

The report also anticipates new open-architecture business models in which entities originate loans and different entities hold or manage them. Banks could retain client relationships and fee businesses while distributing loans through syndication, forward-flow agreements, asset sales and synthetic risk transfers. Insurers, particularly those with fixed annuity liabilities and offshore balance sheets, may move upstream into origination, which McKinsey says can improve general account yields and ROE. Alternative asset managers have acquired insurance carriers and used offshore reinsurance to build permanent capital. McKinsey adds that scale will be a cost of entry for larger financings, and that technology, including AI, automation and digital lending platforms, will be critical. The firm warns that elevated losses are likely in a recession and that prudent underwriting and clear investor communication remain essential.