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Unpacked: Private credit
Private credit is a key source of capital for middle market companies looking to expand their businesses — and, increasingly, an alternative to public market transactions for bigger firms. But how exactly does it work? This is private credit: Unpacked.
Unpacked: Private credit
Private credit isn't a new idea. It's been around for thousands of years. Before public markets developed in recent times, the vast majority of all lending transactions throughout history were effectively private credit, in which lending is negotiated directly between the lender and the borrower. This was true as far back as ancient Mesopotamia, when farmers would borrow seeds to plant and then repay the lender after the harvest.
Today, asset managers are increasingly active lenders in the private credit market, and banks have developed private credit solutions as well. So how exactly does private credit work, and why is it in the spotlight? This is Private Credit: Unpacked.
In a public syndicated credit market transaction, a loan is typically underwritten by a bank and then distributed to investors, either as a term loan or a bond. But in a private credit transaction, the lender lends the money directly to the borrower without the intention to distribute the loan to investors later on.
Private credit is popular among smaller companies in the middle market that do not have access to the public markets. It is also popular among firms that don't qualify for traditional loans, like those without a strong credit history. But as non-bank lenders have gotten larger, they have also begun lending to bigger companies seeking quicker execution, certainty of price, and in some cases, more flexible, tailored solutions. This is because the lender and borrower are able to negotiate terms directly with each other.
There are four main types of private credit. Senior debt: This debt has the highest priority among the borrower's repayment obligations and is often backed by the borrower's assets. It must typically be paid back in full before other debts. Junior debt: This sits behind senior debt in the capital structure, which means it is generally not repaid until the borrower's senior debts have been repaid. It is also often unsecured. Distressed debt and special situations: These are highly specialized types of debt, targeted at companies in financial distress or at unique events such as spin-offs, mergers, or restructuring. Alternatives: Increasingly, the world of private credit is expanding to include more nonstandard forms of credit, such as infrastructure loans and asset-backed finance.
Borrowers in private credit transactions typically do not have public credit ratings. Also, there is typically far less liquidity from a secondary trading perspective, as lenders tend to hold private credit loans until maturity. As such, they seek to charge higher interest rates, called an illiquidity premium.
All in all, private credit is playing an increasingly important role in the broader financial landscape. It is an important source of capital for middle market companies looking to expand their businesses and increasingly, an alternative to public market transactions for bigger firms.
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