Locally and internationally, numerous asset managers are exploring alternate options to meet the needs of their organisations due to the volatility of the market in recent months. Private credit is now an option being sought after by these institutions due to the diversification it provides against rising interest rates that continue to have a glaring impact on traditional bond portfolios. Whilst some entities may view private credit as ‘unnaturalised’, with increased exposure and understanding, this asset class will continue to have some ‘more room to run’.

What is private credit?

Private credit or private debt is an asset class commonly defined as ‘non-bank lending’, ‘direct lending’ or ‘private lending’. It is also a subset of the emerging asset class, being alternative investments. Private credit has been one of the fastest-growing asset classes since the Great Financial Crisis (GFC) that occurred 14 years ago in 2008. As its name suggests, this type of lending is geared towards medium-sized firms. The latter usually chooses, no pun intended, the alternative route, as they don’t have the means to raise capital from multiple shareholders as a publicly listed entity would, as well as the commercial bank being risk averse to the financing needs of the company.

‘Show me the money’

Private lending or debt may take various forms or strategies, with the two commonly used or classified being capital preservation or return maximising. A capital preservation structure would take place through the form of senior debt or direct lending, being akin to the same loan structure the commercial bank normally issues and return maximising through mezzanine or subordinated debt. Interestingly, the word ‘mezzanine’ derives from the Italian diminutive form of the word “middle”, which perfectly describes the position of the loan or facility in a firm’s capital structure, sitting between the pre-existing senior debt as well the firm’s equity.

Private debt tends to generate higher returns and requires stringent requirements prior to funding due to the risks associated with medium-sized enterprises (MSEs). As such, it is not prejudicial for alternative investment managers to conduct the same due diligence as a commercial lender would, as in some cases they are ‘stepping in’ the place of the senior lender. The returns generated from the associated risk being pursued benefits both the lender and issuer.

Why invest in private debt?

Private credit or debt, as mentioned previously, generates higher risk-adjusted returns in comparison to its closest counterpart being traditional fixed income instruments such as bonds and promissory notes. Institutional investors have been increasing their asset allocation towards private debt, in tandem with alternative investment managers, including Sygnus Credit Investments. The former has an asset base of US$135 million which continues to grow. Sygnus Credit is also the largest private credit investment company in the English-speaking Caribbean, well equipped to deploy capital, otherwise known as ‘dry powder,’ into mid-sized firms seeking to expand in a post-COVID-19 economic environment. With the Bank of Jamaica (BOJ) and the Federal Reserve having raised interest rates, a corresponding effect is not far-fetched in regard to private debt rates.

Companies who are seeking private credit as an alternative to traditional lending would be those in need of a recapitalisation of their balance sheet (which commonly takes the form of debt refinancing), an entity seeking financing for acquiring a target firm, as well as those in need of a ‘bridge’ facility, being a short-term loan supplementing the intended longer-term financing due to timing factors. With the BOJ and the Federal Reserve expected to continue raising policy rates in the near future, a knock-on effect is not far-fetched in regard to private debt rates.

Chad-Anthony Coke is currently a Junior Analyst at Sygnus Capital Limited, the largest and leading alternative investment management firm in the Caribbean.