An Insight into
Non-Bank Lending
Private Credit, also known as private debt, is an alternative asset class consisting of non-bank lending where loans are made directly to companies. Unlike a traditional bond, private credit is not traded in the public markets. Instead, the loan is privately negotiated and managed by the institutional manager. As a result, the private credit manager has total control of the loan and retains the legal ownership of the assets that serve as collateral (i.e.: secured).
Private Credit managers impose strong covenants and provisions in the loan agreements to protect investors. As such, recovery rates in Private Credit are historically higher than in public bonds. In contrary, public bonds are mostly unsecured and owned by different constituents. Consequently, owners of public bonds tend to have significantly less control in the event of a default.
Key Benefits of Private Credit
Higher Yields
Private debt usually offers higher rates than traditional public debt. There is a customized premium charged to the borrower for tailored credit solutions. Also, there is an “illiquidity premium” to compensate investors as private loans are not traded daily.
Downside Protection
Most private loans are first-lien (i.e.: senior position) and carry collateral to provide protection. As a result, the volatility and drawdowns in Private Credit are considerably lower than stocks and bonds.
Portfolio Diversification
Private Credit broadens the opportunity set to investors and it is therefore complementary to other fixed-income strategies. Moreover, the correlation to stocks and bonds is very low, thus reducing overall portfolio volatility.
Historical Context
Private Credit is not new. Lending is arguably the oldest investment activity in the world dating back centuries. Private Credit spurred trade around the world throughout civilizations and was the precursor for the banking system in the 1800’s.
Most recently, Private Credit has gotten notoriety as a result of the Global Financial Crisis (GFC) of 2008. The financial burden after the GFC combined with onerous regulations and capital requirements, led banks to retreat and reduce their lending activities. This created a substantial gap in the market, thus providing private credit firms with the opportunity to offer tailored financing solutions to borrowers.
Advancements in technology have also contributed to the recent growth and access of private credit. Historically, private credit was limited to institutional investors like Pension Funds, Foundations, Insurance Companies and Sovereign Wealth Funds. Today, technology has “democratized” alternative investments, allowing individuals to participate with lower minimums, better fees and transparency.
Today Private Credit has gained a significant market share.
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