What is private credit?
Private credit is a subset investment class of private debt. However, in modern times private credit has been used interchangeably with the term private debt.
In essence, private credit is where funds are provided by investors directly or indirectly (via intermediaries, such as fund managers or lending companies) to borrowers that are mostly private businesses.
Private credit is typically the label used for investors, when investing in financial products that loan out funds to other parties. The borrower side, often refers to these financial products as private lending or private loans.
Private credit typically refers to non-bank lenders supplying capital to businesses, individuals, trusts, property developers and SMSFs for LRBAs. Non-bank lenders are lenders who sit outside the traditional banking sector, that are typically not deposit taking institutions (there are exceptions especially in America). They typically lend capital that is their own or that of investors (such as investors, family offices, sovereign funds or institutional players).
Non-bank lenders can include 2nd and 3rd tier lenders, managed funds, private lending companies, individual trusts, individual SMSF’s and investment firms.
Transactions are typically business to business, and not to Individual consumer borrowers, subject to the lending laws in the country. In Australia private lending is not available to individual consumer borrowers as per the NCCP Act regulations. However, in the instance of warehouse facilities, a lender can provide a warehouse facility to another lender, who can then lend those funds to consumer borrowers.
Why do people invest in private credit?
Private credit has been a favourite of family offices and HNW investors for as long as money lending with security has existed. In today’s world private credit is highly sought after by these investors to counter the effects of inflation, taxation, to provide a real return and to offer capital protection.
In many respects private credit, especially where direct lending is involved allows investors to become the bank. We talk about this more in our direct lending private credit page here.
Fixed income
A key feature of or private credit investments is the predictable income they provide in the form of interest repayments. Typically, private credit returns are at a premium to alternative fixed income investments such as term deposits and publicly traded corporate / government bonds.
Private credit rewards investors with a risk adjusted return, illiquidity premium and at times an alpha return (a higher return without taking on more risk) in certain cases of a direct lending or managed funds. Typically, an alpha return is achieved by offering unique financial products, better terms than competitors or speed to deal (you can read more here about achieving alpha in private credit).
Returns can vary from 7% p.a. up to 24% p.a. depending on the financial product and investment manager / originator you are working with.
Diversification
A core part of a successful portfolio diversification strategy is for investors to have assets in their portfolio that are weakly correlated with one another. A key benefit of private credit is that it typically has a low correlation with traditional equities and fixed income assets.
Additionally private credit investments themselves can be diversified with investment into several products and or individual deals, helping to reduce concentration risk.
Private credit is typically charged at a margin above the bank rate. Meaning the underlying bank rank will impact the return investors make. The bank rate can also effect market liquidity, which can impact the demand for private credit and or the ability of borrowers to exit deals.
Security
Security and capital protection is the key reason investors in private credit. Because private credit investments cover a broad range of financial products, each financial product will have different underlying security for their transaction type. Transactions can be backed by a first mortgage over property, a second mortgage, PPSR security over equipment and or a corporate guarantee (these are just to name a few).
Most private credit investments, not only have security, but they have legal enforcement rights and cross guarantees. We strongly suggest you investigate each private credit investment carefully to understand the security and enforcement rights of each product.
How to invest in private credit?
Private credit investors have two ways to invest, either directly or passively via a fund. We break them down below at a high level, but you can read more here for an in-depth understanding.
Whether a person invests in a fund or is a direct lender, largely comes down to their financial capacity. That is not to say family offices don’t invest in funds, on the contrary they do, but they will also lend directly to get a higher return.
Passive investments in private credit
Typically, most investors get exposure to private credit via investments into managed funds. Each fund, even for the same products will have different lending parameters, terms, returns, risk and investment manager skill. Investments here can be as small as $25,000. The downside of most funds, is that you are 100% reliant on the skill of the investment manager, you don’t have deal oversight, and you are in a shared security pool with other investors.
Direct Lending
Investors with the financial capacity also have the option of being a direct lender themselves. This is where the investor will supply the capital directly to the borrower via a loan originator such as us, or through their own networks. This offers high returns, deal visibility and direct security. The downside of direct lending is the added onus of decision making being on the investor and high concentration of funds per deal. Investments here start at $500k.
What is my security with private credit?
Because security is the main feature of private credit, it is imperative investors understand what the security is, the enforcing rights of the fund or investor (if lending directly).
Collateral
Whether an investor has decided to invest in a fund or lend directly the risk and security of the loan largely depends upon the underlying asset that is being used as security.
Investors can engage in a variety of different private credit transactions with the safest being first mortgage private loans, and on the higher side of the risk profile cashflow lending based products. Between these two are a range of asset types and security rankings. This can include first mortgages, second mortgages, company GSAs and PPSR interests against alternative assets
Legal covenants and enforcement rights
Another attractive feature of private credit investments is the legal protection and enforcement rights the lender or fund manager has. These are contractual agreements in a loan agreement that the borrower must abide by, including legal covenants such as maintaining a LVR , certain debt ratios and other covenants. Failure for the borrower to meet these terms, and the borrower can charged penalty interest and other fees, further increasing the returns of investors. In addition to them having to reimburse the lender for any legal costs etc.
Understanding the enforced rights of the fund or your rights as an investor if you are a direct lender is a key to managing risk. Being able to enforce your rights legally, take possession of assets and quickly liquidate them if required is a cornerstone to protecting principal capital.
To read more about private credit investments click here.
To have a confidential discussion about helping build your wealth click here.
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