Introduction
Private credit, also known as private debt, refers to loans and credit facilities that are extended by non-bank entities. Unlike traditional bank loans, private credit is offered by asset managers, investment funds, or private institutions directly to companies. These investments typically target companies that may not have easy access to traditional sources of financing, such as small and mid-sized enterprises (SMEs) or businesses undergoing restructuring or rapid growth.
Private credit has grown significantly in recent years as investors seek alternatives to public markets. According to data from Preqin, the private debt market reached over $1 trillion in assets under management globally by the end of 2022. The rise of private credit has been driven by low interest rates and investor demand for yield, as well as the need for companies to access flexible funding options.
How Does Private Credit Work?
In private credit, asset managers or funds provide loans directly to businesses, bypassing the traditional banking system. These loans can take several forms, including senior secured loans, mezzanine financing, or even distressed debt. In exchange, the lender receives interest payments and sometimes other fees. Unlike public bonds, private credit deals are not traded on the open market, which means that they are typically illiquid.
Private credit investors often negotiate customised terms for their loans, which allows for flexibility in structuring deals based on the borrower’s needs. This can be particularly advantageous for companies that require more tailored solutions, such as financing for a specific project or a complex merger or acquisition. For example, mezzanine loans, which are a hybrid between debt and equity, provide companies with subordinated loans while giving lenders the potential for equity participation, enhancing their returns if the business succeeds.
Types of Private Credit
Private credit includes several different types of loans, including:
Direct Lending: One of the most common forms of private credit, direct lending involves funds or asset managers extending loans to mid-sized companies. These loans are usually secured and come with a fixed interest rate.
Mezzanine Financing: This is a subordinated loan that sits between senior debt and equity in the capital structure. Mezzanine financing is often used in situations such as leveraged buyouts, where traditional debt financing does not fully meet funding needs.
Distressed Debt: Investors in distressed debt purchase the debt of companies in financial trouble, often at a discount. The goal is to restructure the company or influence its operations to turn a profit when the business recovers.
Why is Private Credit Attractive to Investors?
Private credit has become an attractive asset class due to its potential for higher returns compared to traditional fixed-income investments. Since private loans are not publicly traded, investors typically receive an illiquidity premium—an additional return for locking up their capital for a longer period. Additionally, private credit offers diversification benefits as these loans often have a lower correlation with public equities and bonds.
Private credit is also advantageous because it allows for greater control and direct negotiation between lenders and borrowers. Lenders can work closely with the companies to manage risk, sometimes even gaining board seats or the ability to influence key decisions.
Conclusion
Private credit has emerged as a powerful alternative to traditional bank lending, offering companies flexible funding options while providing investors with higher returns and portfolio diversification.
If you are considering private credit for your portfolio, discover how our Private Markets division can assist you in accessing excellent risk-adjusted private credit opportunities by contacting hello@kingsburyandpartners.ae
