Private credit explained

What is private credit?

‘Private credit’ is an umbrella term used to describe the provision of credit to businesses by lenders other than banks. Most commonly, these lenders are regulated asset management firms pooling investor money into funds that are then used to finance respective businesses. The term private credit is also often used interchangeably with phrases such as ‘private debt’, 'direct lending', 'alternative lending' or 'non-bank lending'.    

Private credit is an established but growing sector within the alternative investment market.  It can be differentiated from other types of lending activity and investment strategies in various ways, including:

  • Bilateral relationships:  private credit lenders will often have a direct rather than an intermediated relationship with the businesses they are lending to
  • Buy and hold:  private credit assets – usually loans - are generally not intended to be traded and will be held to maturity by the original lender.
  • A flexible approach:  Core features of a credit agreement such as repayment terms or covenants will typically be structured to match the unique needs of the borrower.

Some of the more common private credit strategies include:

  • Direct lending – lending to performing operating businesses secured by business equity/cashflows
  • Real estate – to real estate projects/developers
  • Infrastructure - to infrastructure projects
  • Distressed – to companies in difficulty
  • Asset based - to business secured by assets (e.g. airplanes) rather than business-generated cashflows as in direct lending
  • Trade finance - to support trade in goods
  • Structured credit - lending with tranching of credit risk
  • Speciality finance - lending to support e.g. consumer credit or peer-to-peer platforms
  • Venture debt - to early-stage companies

Which countries have the most developed private credit market?

The US is the largest market for private credit in the world, accounting for more half of the global market.  Private credit is now growing rapidly in Europe (UK, France and Germany are the largest markets) and Asia with private credit managers investing greater sums of capital in those regions and local businesses becoming increasingly aware of the value of private credit.

Why might a company chose private credit as a finance option?

Private credit can offer business some advantages compared to traditional bank financing.  This may include greater flexibility over the structure of the loan, for example repayment schedules and operational covenants.  The ability to act quickly and value of a long-term partnership with a private credit manager are two other advantages commonly cited by borrowers.

Regulatory measures introduced by policymakers to promote financial stability and support responsible lending practices as well as the simplification of banking business models mean that it is often no longer viable for banks to lend to certain businesses on realistic terms.  This may not necessarily be due to the business posing a bad credit risk, but rather them not being a good fit for a bank’s risk appetite or existing exposure.  In such circumstances, private credit may be a more appropriate source of finance than a bank.

What business sectors or types of companies can access private financing? Can you offer any examples I may have heard of?

Private credit firms generally lend to Small and Medium Enterprises (SMEs) and mid-market businesses across all sectors of the economy. Businesses use this type of finance for a variety of purposes such as acquisition and expansion plans, improving working capital and refinancing existing debt.

Case Studies from Financing the Economy 2020

Ares Management served as the lead arranger for a £1.875bn financing commitment to ‘The Ardonagh Group’.
Ares Management served as the lead arranger for a £1.875bn financing commitment to ‘The Ardonagh Group’, the U.K.’s largest independent insurance broker, through Ares’ global direct lending platform. The financing was comprised of a £1.575bn unitranche loan and a £300m committed capital expenditures facility. The total combined commitment represented the largest ever unitranche financing, which we believe is a testament to the quality of ‘The Ardonagh Group’ and the capabilities of Ares’ global and scaled platform. The financing was part of the company’s global refinancing to support its business expansion plans.

CAPZA arranges a €40m unitranche financing to support ASPY’s organic and external growth.
ASPY, founded in 2006 as a subsidiary of the mutual insurance group ASEPEYO, and independent since 2014, is one of the leading companies in Spain in the occupational risk prevention sector. With c.1,100 employees and  210 centres, ASPY protects more than one million employees and self-employed workers for 43,000 companies. ASPY is now ready for a new stage of growth in which it intends to consolidate itself as one of the leading operators in the sector.   This growth will be carried out organically and through acquisitions: the company is currently in discussions with various SMEs in the sector for potential acquisitions.

INOKS Capital’s funds finance rice production in Ivory Coast
INOKS Capital supports agricultural communities in Ivory Coast to enable local rice production with the aim to improve local rice availability and increase the quantities produced and support more stable market prices. The facility agreement of up to €10m finances the following local activities: purchasing, storing, conditioning, processing and distribution of rice production. Especially due to the impact of Covid-19 it is vital to support financing of smallholder farmers’ cooperatives, improve access to better seed inputs and adopt modern agriculture and irrigation techniques to increase yields in production and enhance food security. 

Prime Capital arranges the largest junior debt financing for renewable energy in Europe to date for MKM Invest Group.
Prime Capital AG has announced that it has arranged junior debt financing of €106m, in cooperation with ENERPARC AG, for a European solar PV portfolio which is owned by the independent power producer MKM Invest Group. The portfolio consists of solar PV projects in Germany, France, and Spain with a total capacity of 579MW. The instrument is cross-collateralised by 94 solar PV projects of mainly operational assets, as well as projects under construction. The transaction is believed to be the largest mezzanine financing in Europe in the renewable energy sector to date.

Altavair Airfinance and KKR Announce $1bn Aircraft Transaction with Etihad Airways.
KKR and Altavair AirFinance (“Altavair”), a leader in commercial aviation finance, announced today the signing of a definitive agreement to acquire a portfolio of commercial aircraft from Etihad Airways (“Etihad”), the national airline of the United Arab Emirates. The acquisition will be made through aircraft leasing investment platform Altitude Aircraft Leasing, which was established by KKR’s credit and infrastructure funds in 2018 to acquire aircraft serviced by Altavair.

Who invests in private credit?

Private credit is an increasingly important market component for investors and is now a permanent fixture of the capital allocation models employed by investors all over the world.  Private credit is predominantly an institutional asset class with majority of capital allocated to private credit strategies coming from pension funds, insurers or sovereign wealth funds.  Family offices, HNWIs and private banks also invest in private credit but make up a smaller proportion of the investor base overall.  Outside of the US there is extremely little retail investor participation in private credit although policymakers are introducing reforms which may improve retail access to private credit.

Further reading

Financing the Economy 2018

What advantages does private credit offer for investors?

Private credit can provide investors with access to illiquidity and other investment premia, support portfolio diversification, and access to a greater range of assets that offer a mixture of income and growth. Investors may also value the 'control' premium whereby private market investors reap the benefits of reduced principal agent problems. 

What would you say to an investor concerned about liquidity issues related to private debt?

Many of the advantages of private credit are inseparable from the less liquid nature of the assets involved.  This should be understood as part of any risk analysis of private credit investment strategies or due diligence on private credit managers.  Harnessing these benefits requires private credit managers to match their investment process with the liquidity risk of the asset – for example ensuring the investment fund or structure aligns with the expected maturity of the underlying assets. 

How is private credit supporting the post-COVID recovery?

While both private credit and private equity strategies target private businesses there are several key distinctions between the two, the most fundamental being the way in which they invest in a business.  Private credit managers will typically invest by providing debt whereas private equity managers will typically invest by taking equity in the businesses. Any choice over whether to invest in the debt or equity of a business will depend on the risk appetite of their investors and the type of return they are seeking.  In broad terms, private credit returns accrue from the repayment of the loan amount plus interest, whereas private equity returns will accrue from an increase in the equity value of the business between purchase and sale.  This means that the returns from private credit and private equity have a very different profiles as each are dependent on different factors.  Private credit and private equity markets therefore allow investors to invest in businesses in a way that aligns with their risk appetite and type of returns they are seeking.

Private credit mythbusting

Private credit managers are unregulated

Not true.  Private credit managers are subject to oversight from regulators that covers almost every aspect of their business.  While the precise framework differs depending on their location or the location of their investment it typically involves authorisation or registration as an investment or asset management business and ongoing supervision or regular reporting on the following key areas:

  • liquidity management
  • use of leverage
  • risk management
  • operational and cyber resilience
  • investor protection
  • business conduct

Private credit managers only lend to bad or risky businesses

Not true.  Many good businesses are no longer able to access long term finance from banks due to changes in the way banks are regulated and the commoditisation of bank business models that has occurred in response.  Having private credit managers available to provide finance to such businesses is one way in which risk can be more efficiently allocated across the financial markets.

Private credit managers employ a low standards of due diligence

Not true.  Private credit managers employ a high standard of due diligence on any potential investment or lending opportunity in keeping with their investment mandate and typically invest in only a small percentage of the businesses they assess.  This approach will often take several months and involve substantial interactions between them and borrower, including the provision of detailed financial information, an assessment of the management team and draw in 3rd party expertise. 

Borrowers must choose between banks and private credit

Not true. Private credit firms have close ties with traditional banks, and many have established formal partnerships. Many companies financed by private credit have obtained bank financing either prior to or during their involvement with the private credit manager. An increasingly popular trend in recent years is banks and non-banks working alongside each other to provide the borrower with the best available finance option across their different business needs. Furthermore, many businesses want to diversify their own financial exposure and access the tailored solutions that private credit managers can provide.

Private credit managers only lend to private equity backed firms

Not true.  While sponsored lending - loans to borrowers where a private equity sponsor owns equity in the company – account for the biggest proportion of lending by private credit managers, they also lend a substantial amount to companies without any private equity investment (often described as non-sponsored lending).  This is a growing part of the market and non-sponsored lending is expected to continue to grow as more businesses become familiar with the advantages of private credit.