For this article, let us start with a proper definition for private credit: “Private credit is an asset class defined by non-bank lending where the debt is not issued or traded on the public markets. Private credit can also be referred to as direct lending or private lending”. *

Private credit as an asset class is becoming increasingly popular simply because there is a lack of returns in the more traditional asset classes while private credit still offers attractive returns. The question is, why is this the case and why have the returns on the more traditional asset classes been diminishing in relative terms? There are many reasons and explanations for this, but let us briefly summarise this phenomenon as follows: In essence, it is a matter of supply and demand, and in this case centres around the supply of money, also referred to as liquidity, in the financial markets.

The world markets are flooded with liquidity as central banks have been aggressive in supporting financial markets through quantitative easing and extremely low interest rates since the global credit crunch (“GCC”) in 2008/9. All that liquidity has found its way into the world’s financial markets and especially in the tradeable markets for equities and bonds – sending asset valuations higher with the resulting lower yields (returns) on these assets.

However, this liquidity flow has not found its way into the unlisted private credit space to the same extent, and hence its pricing offers relative value. In addition, private credit is a specialist alternative asset class and often uniquely negotiated, i.e. not standardised and thus not easily tradeable in the financial markets, which prevents excessive yield compression. This is a global phenomenon, with the result that it has triggered a chase for yield outside the traditional markets, and hence the demand for private credit as an alternative asset class in the quest for return on investment.

Both historically and traditionally, the biggest players in the private credit market have been the commercial banks. The banking sector however has been subjected to stringent constraints and a new regulatory dispensation since the GCC – which has constrained their ability as a supplier of funding to the private credit market. Thus, with reduced supply from the commercial banks, but increased liquidity in the financial markets alluded to before, the void has been filled to some extent by the non-bank lenders. Given the lack of yield, the interest from non-bank lenders as investors has increased in this space.

What makes private credit an attractive investment proposition?

•  It is a good portfolio diversifier as an alternative asset class next to the more traditional asset classes;
• It allows for flexible negotiated terms in concluding bilateral transactions with borrowers;
• Investors can earn attractive risk-adjusted returns, provided they apply good credit risk management and operational processes;
• Private credit investments are not on listed exchanges, and hence their valuations are not subject to the volatility of the financial markets, and
• Private credit transactions are typically imbedded with investor protections as they are structured with security packages in place.
  
  Given the current global COVID environment, there are several market conditions to take note of:

• Economies are experiencing deep dislocations globally, which are disrupting supply chains, including the availability of finance;
• The credit market is offering many opportunities in selected industries and secondary market activity. This is expected to last for the next 2 to 4 years;
• As a result of the increased default risk environment, investors require better protection, lower LTV (Loan-to-Value) and improved risk-based pricing. This will also result in a better workout environment going forward, and
• There are forced sellers of private credit assets currently, which provides for interesting opportunities.
  
  For private credit investors to make use of the current credit market opportunities, investors need to have the following in place:

• Available capital to deploy;
• Good market relationships to capitalise on secondary market opportunities;
• Flexibility in their investment appetite to be able to participate in:
  • Post-restructuring finance,
  • Secondary market opportunities, and
  • Exposures over the entire capital spectrum of companies.

Finally, when selecting a private credit manager, a prospective investor in this asset class will want to see the following critical building blocks in place:

• Strict credit investment selection criteria and process;
• Clearly articulated post-transaction asset maintenance capability including a workout and restructuring track record, and Portfolio design and construction that optimises deal size with exposure diversification. Portfolio design and construction that optimises deal size with exposure diversification.

 *Definition by Wikipedia