Private Credit: Key Investment Characteristics

March 1, 2023 - Private credit has become an institutionalized and deeply capitalized asset class over the past ten years. But what exactly IS private credit? In this series, HighGround Director of Private Markets Philip Godfrey shares his expertise about the asset class, outlining its key characteristics in this post.

Private credit is defined by its high predictability of expected returns, and unlike other equity and debt strategies, success in private credit investing is not driven by an ability to predict the future. Loans originated by private credit managers are designed to deliver reliable income streams in both healthy growth and deteriorating market environments. Private debt investment strategies are based on a carefully coordinated set of key features that work together to provide income and safety when market shifts and shocks occur (e.g., COVID-19 pandemic, Russia-Ukraine war, supply chain issues, inflation and interest rate spikes, etc.) and when companies run into unexpected circumstances. 

Private loans are originated by private-equity backed and other privately-owned companies and are typically senior-secured (“1st Lien”) securities, with priority over junior debt or equity in the company’s capital structure. These loans are priced above a base rate and are periodically reset to the market’s cost of capital. These “floating rate” loans provide yield protection against rising interest rates and generate current income through the quarterly payment of coupons and fees from origination and management of the loans. Asset managers (“The Lenders”) emphasize careful underwriting and structuring of the loans to provide the appropriate amount of leverage and cash flow coverage for the corporate borrower. Lenders negotiate covenants in loan agreements that enhance their rights as senior debt holders, providing strong legal and downside protections over the term of the loan. 

These elements of customization are attractive to corporate borrowers, as access and availability to capital is of high value when completing an acquisition or funding a growth initiative. Whereas a syndicated bank loan or bond issuance may take six to eight weeks or more to underwrite and distribute, privately negotiated loans can be structured and completed within four weeks. Corporate borrowers view this speed and certainty as a benefit they will readily pay for. In addition, private credit managers are adept at tailored solutions to address the complexity and specialized requirements of borrowers in certain sectors or in periods of market dislocation. Customization and commitment to execution of loans by private debt managers provide significant advantages over the traditional bank loan market, particularly for smaller and middle market companies.

In our upcoming and final installment, Philip will cover the various approaches to investing in private credit.

Other posts in this series:
Private Credit: Definitions
Private Credit: The Evolution of an Asset Class
Private Credit: Approaches to Investing