Private credit is the provision of loans (credit) in private markets from a non-bank party where the debt is not issued or traded on the public markets. To understand the basis of it, one must appreciate the nature of private markets and the nature of the credit being provided in those markets. Private markets are an alternative to and different from public markets. Private markets are highly reliant on high touch private investors such as venture capital, private equity and private debt, and offer unique investment opportunities not available in public markets.
Public markets, under the efficient-market hypothesis (EMH), are markets in which asset prices reflect all available information. To initially determine a price, a securities issuer retains an investment bank to solicit opinions on assets prices (through underwriting, analysts, and investors), arriving at a value for an asset through information sharing. That security is then tradable, provided that information is continuously shared. The required administration and costs are significant for the initial and ongoing disclosures such that the size of the issuance must be substantial enough that it can bear the costs of public listing, allowing for liquidity, price discovery and efficient market pricing.
Private markets are inherently less efficient as they often apply an auction like process for price discovery, they are less liquid, and they may not have the fulsome continuous disclosures and continuous repricing provided by the public and EMH. Private markets offer investments that are not widely available to the public, with longer term investment time horizons and unique structures. A common theme in private investing is that underwriting and governance tend to be led by one or very few lead investors and these investors are high touch and integral to the investments monitoring. This is in contrast to the passive role most investors take in public market investing. Assets financed in private markets can include real assets (roads, commodities, infrastructure, real estate etc.), companies that wish to remain private, companies that do not have the size or scope to be public, or companies that may hold specific geographic or business models that by size or type don’t lend themselves to public markets. Private market investments have liquidity constraints which benefit long term capital providers, however, trading these assets can be a lengthy and costly process. This illiquidity promotes long term investment thinking over short time horizons which may favour certain asset classes, strategies, or attract different managers to certain companies. Lastly, private market investment strategies are often specialized. They can be event driven by targeting the growth, reflation and transformation that result from changes in the economic cycle, balance sheet, specific assets by geography and size, or specific stages in a company’s lifespan from early-stage high growth, to long term no growth infrastructure.
Credit (from Latin credit, “(he/she/it) believes”) is the trust which allows one party (the investor) to provide money or resources to another party wherein the second party does not reimburse the first party immediately (thereby generating a debt), but promises either to repay or return those resources (or other materials of equal value) at a later date. In 2006, Bond first published its white paper on mezzanine finance which breaks out credit stratums and payment streams by priority on cash flows and or assets. Where a payment stream has a current component, we call this a debt (or credit attribute) and where it is deferred, we define this as an equity attribute. Where a payment is more certain and defined, such as an interest payment, the return is more debt-like. On the other hand, the more variable a payment is the more equity-like. Seniority of cash flows and asset security can vary tremendously by stratum and silo and various combinations or permutations thereof can be used to customize a debt or equity security into a hybrid. Private credit funds can occupy a single type or many as shown in the chart below.
Private credit is a term used to describe non-bank groups that provide credit in private markets. Traditional banking strategy has been to provide standardized loans at low cost and in high volumes. Banks’ access to central bank capital and low-cost deposits often enables them to be the low-cost provider in private markets. However, to manage the mismatch in duration between current deposits and overnight borrowing from central banks and longer-term loans banks make, banks are highly regulated. These regulations (i.e. Basel III, Dodd-Frank) have restricted the traditional bank in its ability to service certain credits. Moreover, traditional banks use credit models and technology necessary to manufacture generic loans at the lowest cost. This allows private credit providers to target niche credit transactions at higher costs.
Supplying private credit is attractive to investors searching for improved yield and enhanced fixed income in today’s low yield public markets. With its added flexibility, private credit is taking substantial market share from traditional banks. As private credit providers specialize in specific structures, geographies, industries, sizes and other custom features, they are increasingly competitive with banks. While private credit continues to evolve, it remains highly reliant on higher touch, unique and custom solutions to generate higher returns than public markets at the expense of immediate liquidity.
About Bond Capital
Bond Capital is an award-winning private credit fund. As a direct lender, Bond Capital provides advice and money across the entire risk curve. Bond Capital structured credit financing enables business owners to maintain control ownership in exchange for yield and capital preservation. Across multiple cycles and for nearly 20 years, Bond Capital has advanced secured investment quality credit to lower middle market companies throughout North America.