Alt Asset 1 - Private Debt/Credit

What is Private Debt/Credit?

Private debt, also known as private credit, is an alternative investment class where funds provide loans directly to companies, bypassing traditional bank loans or public market funding. This type of lending has grown significantly over recent decades, particularly in established markets like the United States and Europe, where private debt funds play a vital role in financing company buyouts, expansions, and acquisitions. Unlike traditional debt markets, which are dominated by large banks and syndicated loans, private debt offers a tailored approach to funding, often meeting specific needs that mainstream lenders may not address.

Private debt funds use a range of strategies to cater to different types of borrowers and investment goals. These include direct lending, where funds directly finance companies, often with fewer restrictions and faster turnaround than banks; venture debt, which provides growth capital to startups and early-stage companies; and special situations, focusing on distressed or unique opportunities that may require flexible structuring. They also offer various forms of debt, including senior debt (which has repayment priority), junior debt (subordinated and higher-risk but with higher yields), and mezzanine debt (a hybrid that blends debt and equity features).

These loans can go to both public and private companies, as well as to real assets like infrastructure and real estate. Many investors choose private debt strategies to earn income and strengthen their traditional fixed income investments. In the last 20 years, institutional investors' allocations to private debt have grown significantly, from about $58 billion to nearly $1.5 trillion, as mentioned by FS Investments.

Currently, borrowing rates are high, with base rates over 5% and spreads on private loans adding about 500 basis points, pushing the total cost for private equity firms to over 10%. This cost is higher than past rates and current expectations, reducing the number of leveraged buyout deals.

Despite this, private credit attracts significant investments due to its floating rate nature, matching the vast need for financing in the markets with the trillions waiting in private equity and about 300 billion in private credit dry powder.

Benefits of Private Credit to Borrowers

Private credit offers several distinct benefits over public credit, especially for private equity sponsors:

1. Certainty of Execution: Private credit provides a higher degree of certainty in funding. Unlike public markets, where a syndication and ratings process can take months and might still fail, private credit arrangements can be finalized more swiftly and with greater assurance that the funds will be available as planned.

2. Simplified Process: The process for securing private credit does not involve the complex, time-consuming steps required in public markets, such as extensive syndication efforts and undergoing a ratings process. This streamlined approach can be crucial during time-sensitive acquisitions.

3. Support of Healthy Competition: Private equity firms value the balance between public and private markets. By engaging with both, they foster competitive conditions that can lead to better terms and more innovative financial products.

4. Capability for Larger Deals: As the private credit market matures, managers are now capable of handling even larger and more complex deals, which were traditionally the domain of syndicated public markets. This ability attracts private equity firms that require large-scale financing solutions with reliable execution.

In this chapter we will be covering the following topics

1. Returns on Private Credit

2. Market Share and Growth of Private Credit

3. Types of Private Credit

   1. Direct Lending

   2. Distressed Debt

   3. Special Situations

   4. Venture Debt

   5. Asset-Backed Lending

   6. Invoice Financing

4. History of Private Credit

5. Terms Used in Private Credit

6. Working of Private Credit

   1. Private Credit and Private Equity

   2. Importance of Underwriting in Private Credit

   3. Banks and Private Credit Funds

   4. Evolution of Business Development Companies (BDCs)

   5. Leverage in Private Credit

   6. Trading of Position in Private Credit

   7. Strategies for Private Credit Funds (Individual or Platform)

7. Sector Specific Funds

8. Important Metrics

9. Distressed Debt

10. Current Challenges

11. Use Cases for New Technology in Private Debt

12. Solutions