Private Credit Poised for Sustained Growth
After the Global Financial Crisis in 2008, banks became constrained by regulatory mandates (e.g. Volcker, Dodd-Frank, Basel, etc.) that assigned punitive risk-weightings to certain assets, which resulted in reduced lending. In direct response, non-bank lenders and specialty finance companies stepped in to fill the void. Similarly, this phenomenon is playing out again today, as banks are once again risk-off as they continue to tighten already tightened underwriting (as evidenced by recent Federal Reserve Board (FRB) Senior Loan Officer Opinion Surveys) and focus on managing existing clients (as opposed to taking on new clients) as they prepare for economic weakness and inevitable additional regulation in the wake of FRB interest rate hikes and the 2023 bank crises. Coromandel Capital believes this will be a boon for an already booming Private Credit market.
And not only has Private Credit growth been strong, but so has its relative performance. Kroll Bond Rating Agency (KBRA) recently noted that within its universe of Asset Backed Securities (ABS), Private Credit ABS exhibited more favorable rating performance than its Public ABS peers. KBRA attributes Private Credit’s outperformance to lower advance rates as well as better trigger and covenant packages. Coromandel Capital concurs, but would add that Private Credit, especially within its niche of structured credit to specialty and financial technology (“FinTech”) companies, targeting to deliver strong risk-adjusted returns due to additional benefits, such as:
- Exhaustive analytics on underlying collateral that is then subject to eligibility criteria and other collateral constraints.
- Security afforded by liens on diversified pools of assets that are generally self-liquidating and facilitate debt service.
- First loss (i.e., equity or haircut) capital ahead of the secured debt to absorb underperformance and align incentives.
- Targeted portfolio construction across industries and assets with low correlation to the macro economy.
Comparatively, this tends to result in lower default rates and higher recovery rates than middle market secured loans, as well as more security and lower volatility than mezzanine debt or equity given its seniority in the capital structure. Tod Trabocco, CFA from Aksia wrote an article on why Private Credit has higher recovery rates than bonds and broadly syndicated loans, as being the single (or a handful of) lender(s) in the case of Private Credit permits responding more quickly and aggressively to maximize recoveries after distress and avoid moral hazard.
Coromandel Capital focuses on companies that have generally raised a Seed or Series A. Typically, they tend to be run by seasoned management with industry subject matter expertise that is using the proliferation of technology to acquire customers in a differentiated fashion at lower costs while utilizing data to more efficiently deliver services to its customers. Historically, this segment received less focus from Venture Capitalists (VC) than later stage (i.e., Series B to E+) firms, but in recent years Seed and Series A stage companies have garnered more institutional dollars. CB Insights recently noted that Seed and Series A raises by Andreessen Horowitz, Accel , Sequoia Capital, Insight Partners, and General Catalyst comprised ~37% of all deal share in 2019, as compared to ~60% in 2023. Coromandel Capital views this development favorably, as top tier VCs appear to be laying the groundwork and allocating more resources to earlier stage companies. This positive development accretes to Private Credit investors like Coromandel Capital, as early-stage companies are better capitalized to support operations, extend runway, as well as contribute first-loss equity capital to support debt facilities and potential higher underperformance. Coromandel Capital believes that this trend with Seed and Series A firms offer more excess unlevered return, as compared to later stage companies.
Collectively, these developments reflect the confluence of many positive factors that should drive sustained growth in Private Credit with the opportunity to generate substantial alpha given current market dislocations.