Private credit explained
Private credit is credit that is extended to companies or projects on a bilaterally negotiated basis. It is not publicly traded such as many corporate bonds and is originated or held by lenders other than banks. It takes various legal forms including loans, bonds, notes or private securitisation issues. Private credit encompasses various strategies including real estate debt, distressed debt, direct lending, mezzanine financing and structured financing.
Further readingFinancing the Economy 2017: The role of private credit managers in supporting economic growth (2017)
Alternative credit, private debt or direct lending funds are an additional source of funding in the economy especially in times when credit is constrained. They finance companies whose access to more traditional means of bank lending is unavailable, perhaps because those businesses are complex, are in need of bridge financing to restructure and function as a going concern, or because as start-ups or small or medium-sized companies they find it difficult to borrow from commercial banks. Alternative credit funds are also extremely active in financing real estate and development activities, infrastructure projects, trade finance and other forms of credit provision which require bespoke expertise and flexible capital.
We also believe alternative credit funds help to increase the resilience of the financial system as the activity they undertake does not involve maturity or liquidity transformation - the practice of making long-term loans on money that has been deposited by customers on a short-term basis (and could be withdrawn at any time) - or the use of significant leverage.
Further readingFinancing the Economy 2015 - AIMA paper on the role of alternative asset managers in the non-bank lending environment (May 2015)
The main driver of this growth has been twofold. Firstly, there is strong demand from borrowers following the retrenchment of banks from some lending markets. Secondly, alternative lenders who provide private credit have now developed sophisticated, streamlined processes tailored to the lending market. They have been able to offer an alternative to traditional lending that is highly flexible, able to be structured in a complex manner and comparatively fast-paced. From an investor perspective, performance across the private credit sector has shown strong yield relative to many other asset classes.
Among the most popular borrowers of private credit are SME and midmarket companies. Typically, they are too small to raise financing through the public corporate bond market and have also been negatively affected by the ongoing stresses in the banking world. Borrowers are using the loans for a variety of purposes – all of which are vital in their respective developments. Pursuing acquisition and expansion plans, improving working capital and refinancing are all common uses of this finance.
A large number of private credit firms are made up of industry professionals with banking, private equity, hedge fund and traditional asset management career backgrounds. Their expertise and knowledge of local capital markets has led them to develop operations tailored to providing finance to the economy. Some have a real estate focus, others are sector specific while some focus only on markets and transactions of specific sizes.
More flexible terms, such as bespoke repayment schedules and operational covenants, sophisticated deal structures that would be difficult to execute in a banking business, the ability to act with speed and rigour and the long-term partnership offered by the lender are commonly cited advantages of seeking alternative sources of finance. Negligible leverage and closed-end funds also mean that the lending is provided in a manner that is less likely to generate financial stability concerns.
Borrowers normally use the funds for the purpose of expansion, supporting a wide range of economic activity. A typical borrower is a mid-market company or real estate developer, sectors that make up a large proportion of the workforce in most major economies.
Some of the world’s largest pension funds and insurance companies are providing capital for private credit firms. Furthermore, they are comfortable with the closed-end, long-term nature of the funds, typically around eight years.
Alternative lenders have close ties with traditional banks and many have formed partnerships with one another. Banks are a useful source of credit opportunities for alternative lenders and the latter are able to hold certain investments on their balance sheets that are restrictive for banks. Furthermore, some borrowers actively seek partnerships with both alternative lenders and banks due to the additional expertise and findings they can bring.
The US is the largest provider of capital into private credit firms while European countries have been providing some of the most interesting opportunities to alternative lenders in recent years.