What Is Private Credit?

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Private credit can otherwise be described as private lending, direct lending or non-bank lending. It is an asset class where the debt is not traded on the public markets. 

The Purpose Of Private Credit

Private credit helps private companies facilitate their daily operations. Unlike public companies, private organisations do not have access to the same finance options like stocks or bonds. Therefore, private companies borrow money from private lenders to keep their business going.

Private credit has become more popular recently among institutional investors who may experience additional benefits in exchange for increased risk. Some of these advantages include capital deployment opportunities, yield enhancement and potential diversification.

There are a large array of debt instruments within private credit and this also consists of a risk/return profile. Due to focusing on companies with limited financing options, asset classes have a higher risk of default.

A global survey was carried out a few years ago and it was found that 91% of institutional private credit investors planned to keep or increase their private debt allocations in the future.

The reliance on private credit can be attributed to a few different factors such as borrower appeal, greater returns for lenders and less focus on traditional bank lending.

With borrower appeal, private credit can allow extended maturity profiles which gives borrowers more time to pay off debts.

Lenders can receive greater returns as there may be higher interest rates in the private credit market and lead to higher yielding.

Whereas, less traditional bank lending has derived from banks being reluctant to lend funds to riskier borrowers. As a result, private credit has become a solution for many smaller businesses.

The Risks Of Private Credit

Despite the many pros of private credit, there are some negatives that increase the amount of risk involved with borrowing money.

For a start, private credit tends to be illiquid which lengthens the investment time of horizons. So borrowers may have to pay funds back for a longer time than if they were to borrow money from a bank.

Furthermore, interest rates can fluctuate which can increase the amount of interest paid by the borrower with a floating rate term.

Finally, there is credit risk where nonpayment of scheduled principal interest payments can lead to default.

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