3 minute read
MODERN FINANCE
MODERN FINANCE: My Name is Credit, Private Credit
By Philip Dudley
While many investors have been starved for income from the bond market since the 2008 Great Financial Crisis, the sands have been shifting in the creation of credit from traditional banks to private lenders. Are these non-bank lenders a Goldfinger-like villain or are the traditional banks to blame?
The growing demand from privately held companies, which are focused on growth, are turning to non-bank lenders for credit to meet their capital needs. This new pipeline of direct loans (circumventing the red tape of traditional banks) has efficiently and seamlessly grown to more than 20 percent of the U.S. market for below-investment grade credit.
While this may make investors cautious, it’s important to remember that these private loans are senior secured and often are floating rate with plenty of cushion in the capital stack below in the form of junior debt securities and equity. Plus, in the event of a company’s liquidation, senior secured is in the strongest position of principal protection.
Let’s consider the following scenario. When Goldfinger & Co. is in need of growth capital, it now has a more direct and efficient way to access it. The non-bank lenders raise institutional money (of which there’s a ton) and usually partner with private equity firms and their portfolio companies. This exercise of cutting out a middle man (the banks) usually results in a cleaner transaction with higher efficiency and greater term structure flexibility for the borrower.
There are two obvious reasons. First is bank consolidation. Second, the regulatory landscape has changed dramatically since the Great Financial Crisis.
Like most free markets, new participants have filled a void with greater efficiencies and have thrived, while the bankers are struggling with regulatory oversight and shrinking their lending platforms. In fact, Private Credit has grown from roughly 5 percent to 20 percent-plus of the belowinvestment grade credit in the last 15-plus years. In essence, banks are slowly no longer becoming the lender of choice.
So, why take the risk? Like anything, diversification matters and adding Private Credit to a balanced portfolio may actually reduce risk, increase yield and annualized returns.
Several ways to mitigate risk begins with sound underwriting and ensuring the loan is made to scaled businesses that are in sectors with strong secular tailwinds.
What about volatility? Well, because the Federal Reserve has raised rates 500 basis points in only 12 months, there have been benefits for both non-bank lenders and investors in the form of better loan terms (banks are not lending) and higher income because of floating rate features. A real win-win for Goldfinger!
