INVESTING IN PRIVATE CREDIT
What Is Private Credit?
Understanding the Basics and Beyond
With a robust supply of asset-based investments, the private credit market has grown to over $5T dollars and is anticipated to be worth nearly $8T by 2027, driven by structural shifts in the lending environment.
What is private credit?
Private credit refers to lending to borrowers who do not have access to traditional liquid markets or bank financing. It includes general corporate loans, secured by a company's assets or cash flow, and asset-based loans, secured by specific tangible or intangible assets such as equipment or financial securities.
Why is it necessary?
Support for small and medium-sized businesses: Most businesses globally are small or medium-sized and require smaller loan amounts than those typically available in liquid markets. Private credit provides these essential loans.
Filling the bank lending gap: Post-financial crisis regulations have restricted banks from lending to highly leveraged businesses. Private credit fills this void, especially for privately or family-owned businesses.
Diversified financing needs: Different businesses have varying financing needs, some requiring specific asset-based loans. Private credit caters to these diverse requirements more flexibly than traditional banks or liquid markets.
By addressing these needs, private credit ensures businesses have access to the necessary capital to operate, grow, and sustain their activities, thereby supporting broader economic stability and growth.
Corporate and specialty lending
This growth is supported by the attractiveness of the opportunities to investors. Private credit provides the potential for substantial and differentiated returns; access to broader opportunities and greater diversification backed by hard assets, contractual revenues and defensiveness on the downside.
We see two key areas for investors that provide unique benefits to a broader portfolio.
Each of these areas comes with their own set of opportunities, risks and complexities that you can explore below. A multi-manager approach provides investors with better access and control to reap the benefits of private credit while maintaining a diverse portfolio to optimize risk-adjusted returns, capitalizing on various market conditions, and enhancing overall portfolio resilience.
How do private credit strategies make money?
Coupon:
Typically, the Secured Overnight Financing Rate (SOFR) +5-7% on senior debt (~11% in today’s marker), SOFR +8-10% on second lien
Fees:
Origination fee typically ~3% on each deal or refinance, prepayment fees of 1-2% in the first 1-3 years, ad hoc fees for covenant amendments
PIK interest:
Pay-in-kind interest conserves cash for the borrower while increasing back-end returns for the strategy
Equity kickers:
Often in the form of penny warrants that grant convertible bond like upside to the deal
Securitization:
Pooling of loans and selling top tranches to retain excess interest
Private Credit Factors
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Lisa Schneider, CFA
Managing Director,
Head of Client Solutions
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