Intro to Private Credit

Intro:

• TLDR: private credit is any loan that isn't a bond (not publicly traded) and not issued by a bank
• The non-investment grade credit markets in the US and Europe have expanded threefold in size since the Global Financial Crisis (GFC), growing from $1.7 trillion to $5.1 trillion.
• Companies in need of debt financing can either turn to banks for a loan—which would then either hold the loan on its balance sheet or syndicate it to a group of similar investors—or they can turn to private credit. 
• Private Credit: loans provided by lenders other than banks. Private credit funds lend directly to companies, often without using investment banks as an intermediary. They hold the debt and collect interest, rather than sell it off in pieces to other investors like a bank would.
• While a PE firm buys all or some of a company, private credit firms lend money to a company directly.
• AKA: In private equity, you are the owner of the business, and when it comes to private credit, you should operate under the assumption that the worst-case scenario could occur, meaning you don't participate in equity upside, so it's crucial to ensure you receive at least the interest payments.

Loan vs. Bond:

• Bond = publicly traded
• Once issued, can be bought and sold
• Loan = not publicly traded
• Once issued, loan is on your books until paid back, can't be traded

Cash flow-based lending:

• payment is predicated on ability to pay back interest

Asset-based lending:

• collateral-backed

Different Types of Private Credit:

1. Direct Lending
• Form of private credit investment where investors provide loans directly to small and medium-sized enterprises (SMEs) or other borrowers without involving traditional banks/financial institutions.
• Loans may be with or without collateral and can be structured as term loans (fixed-term lump sum loans with set repayment schedules and interest rates) or revolving credit facilities (flexible financing arrangements that allow borrowers to access funds up to a pre-approved limit, repay, and re-borrow as needed during a specified period).
2. Mezzanine Financing
• A hybrid form of debt and equity financing that gives the lender the right to convert the debt to an equity interest in the company in case of default.
3. Distressed Debt
• Purchasing debt securities of distressed companies at a significant discount to their face value.
4. Asset-Based Lending
• The loan is backed by the borrower's assets, such as accounts receivable, inventory, or real estate. 
5. Real Estate Debt
• Providing loans for real estate acquisition/development/refinancing.
6. Specialty Finance
• Niche lending opportunities that cater to specific industries or borrower needs.
• E.g. consumer finance (student loans), equipment leasing, etc

Why Invest in Private Credit?

1. Good investment for investors in an inflationary and rising rate environment:
• As interest rates increase, returns on credit instruments also increase
• Private transactions are negotiated directly between lender and borrower, with an extensive focus on due diligence and downside protection
2. Option for riskier borrowers:
• In the past, traditional banks used to be the main source of loans for people and businesses. However, many banks became cautious about lending to riskier borrowers. Private credit steps in to help these riskier borrowers
3. Diversification:
• Private credit allows for lots of structural creativity in its investments and diversification

Why is Private Credit Booming?

• Capital requirements, increased regulations make it so that traditional banks can't lend as much anymore
• requirements on balance sheets and regulatory capital ratios make loans not economical
• Banks used to be the main issuers of these loans: lending based on deposits
• deposits = liability, assets are the loans themselves
• Private credit: investor invests in a fund, you as investor get return directly
• Higher returns than public credit:
• liquidity: bond has a liquidity premium
• private credit: You don't know where the credit is invested - sourcing/origination premium. you get compensation for finding the lending business
• Private credit is not as volatile as bond market:
• doesn't get affected by rates as much as bonds
• think of it as investing in real estate vs. investing in rates market
• rates can jump up and down
• selling real estate: you have an idea of prices in neighborhood moving, but the price movements are very gradual
• same thing for private credit: very slow moving adjustment

References:

https://podcasts.apple.com/us/podcast/talk-your-book-what-is-private-credit/id1310192007?i=1000638917398

https://www.gsam.com/content/gsam/us/en/advisors/market-insights/gsam-insights/2022/understanding-private-credit.html

https://pws.blackstone.com/education-insights/article/private-credit-investing-in-rising-rate-environments/