Michael Cibelli, CFA®, Portfolio Specialist, Alternatives: Private Credit. We’ve all heard the term. But what does it actually mean? This is Lord Abbett Explains: Private Credit.
Hi, I’m Michael Cibelli, and today we’re making sense of the term “private credit.”
What Is Private Credit?
Simply put, it’s an alternative form of borrowing and lending money that takes place outside of the traditional banking system or the publicly traded capital markets.
Because the loans are privately originated and not publicly traded like bonds, we get the name: private credit. Instead, the loans are made with the expectation that they’ll be held until maturity.
It’s an important consideration—not just for the lender, who’s holding the loan—but also for the borrower, who will be partnering with that same lender on an ongoing basis for the life of the loan.
This private, non-traded nature of the loans contributes to their low price volatility relative to public debt.
What Financing Options Are Outside the Banking System and Capital Markets?
Let’s unpack that through the lens of small and large businesses. When it comes to financing—smaller or less established businesses historically have turned to commercial banks. Alternatively, some have gone the private credit route, working with non-bank lenders that specialize in middle-market business loans.
For larger companies, the financing landscape looks a bit different. These businesses borrow in large enough size that they can partner with a major investment bank, which raises capital on their behalf by tapping investors such as asset managers, institutions, and individuals by issuing publicly traded bonds or loans.
But some of these larger borrowers may choose to skip the middleman entirely and source capital from the private credit markets, opting to secure a loan directly from a private lender, like a private credit fund, a Business Development Company (or BDC for short), or an interval fund.
What’s the Appeal of Borrowing in Private Markets?
While issuing publicly traded loans may be a lower-cost option for these larger borrowers, primarily because they don’t need to offer investors a yield premium for illiquidity, it still may be appealing for companies to borrow privately for a few reasons.
1. Partner with fewer lenders
First, they can partner with one or just a few lenders that have a long-term perspective versus a very broadly syndicated public loan with potentially hundreds of lenders that lack any real commitment to the borrower.
2. Negotiate bespoke terms
Second, they can negotiate bespoke terms with the lender based on their specific needs.
3. Certainty
Third, There is more certainty with respect to the amount of capital that will be available to borrow and the terms of the deal, whereas in the public loan market, the capital raise is on a best-efforts basis, and a longer timeframe until a deal closes may cause the terms initially discussed to differ from what the terms look like at the time of execution, especially if rates or the cost of risk changes in the market.
Periods of high volatility, such as COVID, amplify this uncertainty of execution associated with the public loan markets.
4. Preserve deal confidentiality
Fourth, private deals preserve confidentiality.
5. Reduce reporting burden
And fifth, borrowers can avoid the burdens associated with extensive reporting and ratings requirements.
Does Private Credit Always Involve Corporate Loans?
Not exactly. The definition of private credit has evolved. While it’s often used interchangeably with private corporate lending, it casts a much wider net nowadays.
Historically, it meant lending money to U.S. companies in the form of private, non-traded loans, now estimated to be a $1.7 trillion market.
But today, private credit can be used as a broader term that includes loans for real estate projects, infrastructure financing, and even asset-based loans backed by inventory, equipment, receivables, and/or pools of loans.
Add all that up, and some estimate private credit to be a $40 trillion market.
Let’s Recap…
So what are the three most important points here?
1. Includes private bespoke loans
First, private credit encompasses various forms of private, bespoke loans made by non-bank lenders.
2. Capture broader opportunity set
Second, beyond private corporate loans, private credit can also be used to capture a broader opportunity set.
3. Loans held to maturity
And third, the loans don’t trade in the public capital markets; they’re held to maturity and therefore demonstrate lower volatility relative to public debt.
So, there you have it, private credit 101. Thanks for watching. Be sure to tune in to our next private credit explainer video on direct lending.