By Nuth @Adobe stock

Kat Hidalgo of Bloomberg tells readers that private credit is booming, and banks are fighting back. She writes:

Need a loan for a new factory or a buyout deal, but don’t like the terms your bank is offering? There’s a $1.7 trillion industry that’s ready to help. Private credit came of age after the 2008 financial crisis as an alternative to banks at a time when regulators were clamping down on risky lending by deposit-taking institutions. Today it’s become a serious rival to mainstream lending for all kinds of businesses, from real estate firms to tech startups. Money is pouring into private credit funds from wealthy investors, retirement plans, sovereign wealth funds, and even the banks that compete with them. Some have argued that private credit should become a permanent fixture in capital markets and investment portfolios. Yet it’s not clear how this opaque corner of finance will cope when the next big recession hits.

1. What is private credit?

The origins of private credit can be traced back to the 1980s, when insurance companies began lending directly to companies with strong borrowing records. Today, private credit funds deploy billions of dollars in a variety of investing strategies:

  • Direct lending: Companies borrow directly from a non-bank lender acting alone or as part of a small group. They typically hold the loans to maturity.
  • Distressed debt: Private credit funds snap up corporate debt that’s trading well below its original value, or provide new financing to a company in difficulty, hoping to turn a profit as the business restructures or liquidates.
  • Venture debt: Financing is offered to startups that have yet to make any profit. The loan size is typically based on a multiple of a firm’s recurring revenue.
  • Mezzanine finance: This refers to investments in higher-risk forms of debt that sit between other loans and equity in the queue for repayment when a borrower can’t meet their obligations.
  • Special situations: This covers loans extended to take advantage of a particular event or situation and where lending decisions are often not related to a company’s fundamental metrics such as profitability or growth […]

Private credit asset managers in the US and Europe are already subject to certain requirements for conducting their business and reporting data to regulators. The European Union is now putting more guardrails in place, including caps on leverage — using borrowed money to boost returns — and obliging private credit funds to diversify risk. The US Securities and Exchange Commission is forcing them to make quarterly reports and disclose more information on their expenses. There are also signs that the UK’s Financial Conduct Authority will review the way valuations are decided in private markets. But overall, there are no widespread moves that would bring the regulation of private credit funds in line with that of deposit-taking institutions. In the meantime, many governments are happy to attract more private capital to finance types of lending that they see as too risky for banks.

Read more here.