Private Credit 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 financial needs, some requiring specific asset-based loans. Private credit caters to these diverse requirements more flexibily 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.
Corporate lending is the orientation of loans to companies secured by their cash flow and equity value, provides a stable core exposure with attractive risk-adjusted returns.
Backed by tangible and intangible assets, specialty lending can enhance returns through higher yield while providing diversification.
How do private credit strategies make money?
Coupon
Typically, the Secured Overnight Financing Rate (SOFR) +5-7% on senior debt (~11% in today’s market), 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, equity kickers offer upside similar to convertible bonds
Securitization
Pooling of loans and selling top tranches to retain excess interest
Private credit factors
In corporate lending, direct lending offers stability and predictable cash flows. In contrast, specialty lending can offer higher returns but comes with increased complexity, necessitating a balanced approach.
In corporate lending, direct lending managers can adjust terms and conditions to fit market needs. Special situations manager can even pivot to liquid markets when those are more attractive. Specialty lending managers exploit persistent market shortcomings by offering bespoke lending solutions that can be more recession resistant. This flexibility helps ensure that the portfolio can adapt depending on the position of the economic cycle.
Sponsored corporate lending mostly involves private equity-sponsored companies, offering exposure to robust businesses with substantial equity backing. Specialty lending broadens this exposure by including exposure to distressed assets, heavily structured loans on high quality collateral, and companies undergoing significant transitions.
Applying leverage in corporate lending, particularly in direct lending in the U.S., can amplify returns while maintaining manageable risk levels. Specialty lending often involves sophisticated financial structures, such as PIK deals, which allow for additional compounding interest and returns over time. Special situations managers can even negotiate cheaply priced warrants for equity upside to turn some private loans into an investment that looks very much like a high coupon convertible bond.
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