Private credit – an alternative to bank financing

What is private credit, and why has it become so popular?

Also known as direct lending, private credit is financing provided directly to a company by a non-bank lender such as a private credit fund.

Economic uncertainty and increased regulatory requirements have led banks to become more risk-averse and traditional bank financing has become more difficult for some companies to obtain. This has resulted in an increased demand for alternative sources of financing, allowing providers of private credit to gain market share from banks.

How does private credit differ from a bank loan?

Private credit is usually provided directly to the borrower by a single lender, although we have recently seen private credit provided by small clubs of lenders as well. Private credit loans are in many ways like traditional bank loans in terms of maturity, pricing and documentation.

Similarly to bank loans, more and more private credit loans incorporate features like sustainability-linked pricing. The investor demand for more sustainable and greener financing can also be seen in the private credit market. This will direct the flow of funds in the future more often to companies which support the green transition.

What sets private credit apart is the flexibility that it can offer to the borrower. As private credit providers are not bound by stringent capital and other regulatory requirements, they can often provide borrowers with more flexible terms than banks can, such as higher leverage and a larger portion of bullet repayments or balloon repayments. This allows companies to take advantage of investment and growth opportunities which may not otherwise be possible. Because of this flexibility, private credit has been an attractive option for example for borrowers with lower credit ratings, which may not be able to secure traditional bank financing on commercially viable terms and are unable to issue bonds.

Pros and cons of private credit

As with any type of financing, private credit has its own advantages and disadvantages that borrowers should consider when evaluating their funding options.

Pros

1. Flexibility: Private credit often means more flexible terms for the borrower and a somewhat smoother negotiation process. As the borrower generally deals with a single lender, getting consent and modifying financing terms tend to be simpler.
2. Access to expertise: Unlike banks, private credit providers often have the capacity to support the borrower’s business by providing access to their own business expertise. This can be particularly beneficial for a borrower seeking growth in a challenging economy.
3. Confidentiality: The limited number of parties involved in each private credit deal ensures that the terms remain confidential.

Cons

1. Higher cost, more restrictions: Private credit tends to be more expensive and comes with stricter lender protections than bank loans due to the typically higher risk profile of borrowers who opt for private credit.
2. Lack of banking relationship: In certain cases, the lack of a banking relationship may be an issue as private credit funds are not able to provide access to other banking services that companies need. Moreover, while there is no record of this happening in reality, it has been suggested that a private credit fund might adopt a harsher stance on enforcement if the borrower defaults on the loan.
3. Lack of visibility: Although confidentiality is a great bonus for both the borrower and the lender, the lack of access to data makes it more difficult for market participants to track deal volumes and market trends.

The future of private credit

While bank lending is expected to become more attractive to borrowers as interest rates fall, it is still likely that there will be a demand for private credit. It is even believed that the market share of private credit in corporate lending will continue to grow.

The benefits of private credit remain attractive to borrowers, and the availability of private credit is expected to increase as investors continue to invest in private credit funds in pursuit of strong returns. An increase in supply is likely to result in tougher competition between private credit providers, which may lead to lower pricing and terms more favourable to borrowers overall.