Why is private credit a viable alternative to institutional lending?

Private credit refers to debt financing provided by non-bank lenders to companies and while it may be tempting to treat it as if it is a new source of lending, in reality it is not. It has existed as a form of financing for some time (having started to really take root on the heels of the 2007-09 global financial crisis when a stricter regulatory environment placed increased capital adequacy requirements upon banks) its more recent popularity can be attributed to the COVID-19 pandemic, an ever-tightening regulatory environment for banks and inflationary factors within the market which have propelled banks into a posture of tightened lending standards. While we should all want a stronger, more robust banking sector, the net effect of tightening protocols was the ushering in of slower, more cumbersome processes and limitations for borrowers dealing with institutional lenders. This created the inevitable liquidity hole in the market and in came private credit to plug that hole.

The current macroeconomic conditions, fuelled by a cocktail of elevated interest rates and inflation, have been important factors in the rising popularity of private credit, creating favourable conditions for it to expand its reach. As a market, the approach of private credit (when compared to its institutional lending counterpart), is one of flexibility and innovation, features which are appealing to borrowers. While banks must operate within certain regulatory and procedural strictures, lenders within the private credit market have the flexibility to provide customizable and bespoke lending products to borrowers. At a time of increased fiscal stress for many companies, the appeal in dealing directly with a lender that can provide a customized loan product that suits the needs of the company is obvious. Much of that appeal emanates from the availability of customized direct loan products and lenders who are willing to adopt a tailored approach to each loan transaction. Typical financing sizes range from $1 million to US$250 million and while the pricing of such loans can be higher than that in institutional lending, borrowers are willing to pay those costs for what tends to be a quicker simplified and often tailormade process. Many lenders also approach lending as if they are partnered with the borrower and as a result they adopt business models that are linked to the success of the borrower.

It is often said that small and medium sized businesses (SMEs) are the lifeblood of most economies – and these businesses undeniably need capital in order to operate and expand. These needs have fed a demand for financing and in the absence of ready financing from banks, SMEs have turned to private credit sources. Operating in what is said to be a US$1.6 trillion industry, lenders such as private credit funds, private equity firms and institutional investors with an abundance of money are now in a position to rival mainstream lending and are deploying a multiplicity of flexible lending strategies (such as direct lending, distressed debt, mezzanine financing, asset-based lending and specialty finance) in order to do so.

In essence, the data suggests that the primary advantages for borrowers who obtain financing through private credit include (i) the relationship driven approach adopted by lenders which is fuelled by collaboration between lender and borrower with the common goal of creating circumstances in which a borrower can thrive and grow its business; (ii) the fact that the market provides increasingly innovative and creative financing solutions for borrowers operating in underserved markets such as real estate and infrastructure financing. By aiming to understand each market in which borrowers operate, lenders have gained the trust and appreciation of the borrowers whom they service and (iii) the efficiency of processing loan applications.

Such features are geared towards attracting borrowers and with no real indicators that the market is shrinking or likely to go away any time soon, it seems clear that so long as the market continues to demonstrate the levels of flexibility and innovation that it has thus far, it will continue to grow and gain market share from banks.