Decoding Private Credit: Essential Insights into Private Credit Dynamics in India

As the demand for alternative sources of financing continues to grow, understanding the nuances of the private credit industry becomes increasingly vital. Whether you're a seasoned investor, a budding entrepreneur, or simply intrigued by the mechanics of financial markets, this article aims to demystify the fundamentals of private credit and its role within the Indian economic ecosystem.?

What is Private Credit?

• Lending by a non-banking financial institution, tailored as per the borrower’s requirements
• In private credit, the fund lends money to the company in exchange for interest payments and can impose covenants and/or collateralization that secures the loan.?
• They are called private because, unlike publicly offered company stocks and bonds, the loans (credit) are not available for trade to the general public.
• A typical private credit fund is basically a privately pooled fund having capital contributions from institutions, family offices, insurance companies, pension funds, HNIs, etc., which is actively managed?by fund managers for investing in suitable businesses.
• Private credit has?existed in different forms?for a long time now. After the global financial crisis, increased regulation and high-risk restricted bank lending everywhere and pushed many borrowers (especially lower-rated, mid-market ones) to?private financial institutions?flush with cash from easy monetary policies in developed nations.?
• At present, private credit spans everything from?distressed loans?to?multi-billion dollar buyouts.

How Private Credit is different from Private Equity?

• Private credit involves lending money to borrowers (especially the ones who may have trouble accessing loans from traditional sources and would require customisation in the lending terms). In contrast, private equity involves buying ownership shares in an unlisted company.
• Usually, both these institutions go hand in hand when it comes to providing capital to a company.

Why would a borrower want to take money from Private Credit institutions when we have so many well-equipped banks/NBFCs to lend the money?

• Banks have to stick to the regulatory capital norms and follow sector diversification guidelines to manage the total risk with a key objective of not losing the depositor’s money. Not all good businesses fit the bank’s criteria. Private credit funds being a pooled capital possess much more flexibility and fewer regulations for lending.
• Banks are not known for providing highly tailored and flexible capital as per the sector and the business model of the borrower.
• The majority of the Banks are focused on collateral-based lending and this results in the funding gap for asset-light companies (like services, tech, etc.).
• Private credit generally provides a higher level of certainty, deal execution speed and size w.r.t. the Banks/NBFCs.

But does this mean Private Credit institutions are taking over the Bank’s share in terms of lending in India?

• In India, Private credit will not be growing at the expense of the Banking industry but will be growing alongside the banks as it just fills a certain gap that is there in the capital model.
• In fact, in a lot of cases, the companies which opt for private credit have bank credit lines already in place (for managing the working capital).?
• These companies would require capital for acquisition or would require 3x+ the revenue but the banks may not be well equipped (mostly from the risk perspective) to fund these.
• For instance, as per Reuters, last year Shapoorji Pallonji Group raised INR 143 bn from private credit investors and this deal was marked as one of the largest deal values in the domestic private credit space offering 18.75% yield. The high risk involved, mainly due to the low credit rating, kept the Indian banks away from participating in it.

What are the key sectorial opportunities in India?

• Most of the private debt institutions started with industries having high liquidity requirements like real estate and construction business but now a lot of players are following a completely sector-agnostic approach.?
• This can vary from various EPC companies, manufacturing (huge push through make in India initiatives), companies benefitting from supply chain diversification away from China, and also the services sector (contributing 50%+ to India’s GDP and has business with minimum hard assets to be considered for lending by Banks).

What are Return expectations from an investor perspective?

• Private credit products are structured as close-ended credit-focused alternate investment funds (AIFs) that could offer 13-20% returns per annum while locking in investors’ capital for a defined period.
• As per BPEA Credit Group, there is a huge demand for moderate risk fixed-income products having a 13-15% annual coupon rate.
• S. Sriniwasan, managing director of Kotak Alternate Asset Managers Ltd., recently said in an interview "Today it's very hard to get global capital to come and sign up for 14-16% returns in rupee terms. But domestic capital is very hungry for that kind of yield".?
• Indian high-net-worth individuals and family offices have smaller amounts to invest but also lower hurdle rates or return expectations as they don't face currency costs and withholding tax.
• As per Preqin data, private credit investors?in India had roughly $15 billion of assets under management as of December 2022. As per an interview, Kanchan Jain, head of BPEA Credit Group, the size could double in two years.

Which regulatory body oversees Private debt institutions in India?

• Private credit funds are registered with the Securities and Exchange Board of India (SEBI) and are regulated under the?SEBI (Alternative Investment Funds) Regulations, 2012.
• Money is being invested through CAT II AIFs and the minimum ticket size is a crore plus in INR terms (mainly to keep out the retail investors).
• Foreign fund flows, which have so far dominated investments in Indian private credit, are moderating.

What are the key drivers of demand for Private credit in India?

• The capital could be for transaction requirements like mergers and acquisitions, working capital needs, capital expenditure (capex) or special situations where certain investors need to be given exits.
• Upon analyzing the H2 2023 survey data from EY, capital expenditure is seen as the foremost driver of private credit deals.?
• Also, stress-related and working capital financing exert notable influence, followed by PE Exit financing.?
• Notably, in the December 2022 survey, fund managers predominantly anticipated that Bridge to IPO and special situations would fuel the demand for private credit, with some endorsement for capex financing.?

Can it reopen the old wounds in India?

• The private credit business is characterized by opaque structures, untested valuations and illiquid debt securities.
• Remember the 2018?collapse of infrastructure financier?IL&FS on account of alleged fraud and complex, unsustainable debt structures? The contagion spread across India's credit markets, the?mutual fund industry?and some?large business groups?as well.?
• In 2020, Franklin Templeton was hit by failed high-yield debt bets and had to?shutter six debt funds, freezing ~$4.1 billion of investor assets.?
• In 2021, KKR's India credit unit, which had extended about $800 million of loans at its peak,?was saddled with bad loans?and eventually merged with a competitor.

As per the latest report from EY, the H2 2023 witnessed continuous fund-raising announcements. Based on select public information, the following key fundraisings were announced:?

• Edelweiss Alternatives raised ~US$1b for its third special situation fund – ISAF III?
• AllianzGI has closed fundraise for its secured lending fund of ~US$610m with target returns in mid-teens and ticket size of ~US$25–60m?
• Capri Xponentia is raising its funds with a target of ~US$240m. The fund recently concluded a first close at ~US$53m?
• Vivriti Group closed fundraising for its three private credit funds with a cumulative ~US$200m?
• Axis Asset Management launched a private credit fund and is aiming to raise ~ US$150m. The fund will be sector-agnostic and will seek to generate gross yields in the 13–14% range?
• Sundaram Alternates completed raising ~133m for its corporate credit opportunities fund which shall provide debt finance to MSMEs. Sundaram Alternates also launched its high-yield credit fund which shall raise ~ US$180m, including a green shoe option of ~US$90m, with target returns of ~18–22%?
• True North raised ~US$120m for its private credit fund. The fund will extend performing credit to mid-market companies, with an expected IRR of 15–18% and ticket size of ~US$10–25m?
• Nippon made the first close of its credit fund with a target of ~ US$120m. The fund is expected to have a ticket size of ~US$10–15m?
• Modulus Alternatives (formerly Centrum Alternatives) is raising its second private credit fund. The target commitment is ~ US$90m with a green shoe option of ~US$60m