Private credit proves less scary than feared

Private credit has faced ominous headlines this year. Yet investors may find more treats than tricks when looking beyond them. Institutional investors are not backing away. A recent BlackRock survey, reported by the Financial Times, found that around three quarters of insurers expect to increase their allocations to private markets over the coming year.

Understanding this opportunity requires nuance. ‘Private credit’ is not a single asset class. It is an umbrella term for many lending forms, with a broad spectrum of risk. Investing is not magic. The fundamentals of investment decision-making are similar for public and private credit. Both draw on the same underwriting DNA to assess a borrower’s ability to repay debt. The real challenge is separating perception from underlying reality.

Shining a Light on the Fundamentals

As private credit investors, the role is to turn on a financial flashlight. This means using fundamental credit analysis to evaluate a company’s ability to service its debt. It also means examining the seniority and security of the loan. The goal is to understand the protections available if things go wrong.

By methodically assessing default risk and putting appropriate structural protections in place, investors can strip away the mystique. This ensures they are rewarded for risks that look far less scary under a bright light.

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Types of Private Credit Transactions

Take significant risk transfer (SRT) transactions. These reference portfolios of performing, underwritten loans. They allow banks to transfer credit risk and manage regulatory capital. By securitising this risk into distinct tranches, a transaction can cater to different appetites. The first-loss equity layer bears loan default losses in exchange for a greater return. The more senior mezzanine tranche benefits from the equity cushion and can show investment-grade characteristics.

Or what about direct lending? The concept is straightforward: lending directly to a company instead of through the public bond market. The lender negotiates the loan’s economics, structure, and protections. Recent scrutiny has focused on the US, where some risk appetites look rather aggressive. But direct lending is not a uniform market. European direct lending has historically had lower default rates, stricter underwriting, and stronger covenants.

Infrastructure debt finances tangible assets that keep economies moving. This includes renewable energy grids, regulated utilities, airports, and digital connectivity networks. Their essential nature can support predictable, inflation-linked cash flows from long-term contracts. If you came looking for thrills, you might be disappointed.