Author: IntaCapital Swiss

Private Equity Companies/Partners/Owners are Engaged in Standard and Exotic Loans

Over the last three or four decades executives of private equity companies ruled the roost where investors from all over the world would beat a path to their front door looking to invest in their next big fund. However, times have changed, declining valuations and much higher interest rates have made it harder to sell assets, raise new money for investments and fund distributions to their investors. 

Today the biggest investors or backers of these private equity funds have turned the tables and are demanding more from private equity owners/directors, such as if we invest you now have to invest more of your own money. Throughout the private equity industry, company directors/owners /partners are having to take on debt and pledge their personal assets (homes, paintings, yachts etc) in order to appease their larger investors.

In 2023, contributions to equity from the private equity sector was circa 2% and in 2024 is circa 5%, and according to analysts, in some cases as high as 20%. In order for some of these executives to raise the requisite amount of cash, they have been taking out high interest loans where the rate is anywhere between 10% and 20%, and some banks, so experts advise, are demanding collateral of all personal assets. Such is the need for more cash in the private equity sector, some money managers are now scrambling to get cash, and  private lenders such as Oak Capital Management are making funds available. 

Apart from the personal loans the industry has seen loans that have been rarely used before. Below are a few examples.

*Manco Loan – This is a relatively new loan where appetite is going through the roof. Taken by the entity or management company that oversees the private equity investment, the collateral consists of cash flows such as equity returns or fee streams. This loan is usually used for funding an individual partners’ equity stake in a private equity fund, succession planning (focuses on maintaining a company’s talent and ensuring a smooth transition should existing leadership leave) and seeding new strategies. Currently there is no data available for the size of outstanding loans, but experts suggest that deal sizes range from USD50 Million to USD350 Million.

*Net-Asset-Value or NAV Funding- This form of finance is usually backed by a pool of portfolio companies within a fund, where the funds are utilised by private equity companies to help return money to investors. However, experts in this area advise that this form of finance is likely to dilute returns at later dates and effectively leaves the fund paying an interest rate that is not to everyone’s liking. Estimates from analysts and experts alike suggest this form of financing will increase circa 700% by 2030 to USD 700 Billion.

*Collateralised Fund Obligations – This form of finance bundles stakes in funds holding private equity owned companies, which are then packaged into one security. Risk categories go from senior to equity tranches and coupons are paid from the cash flows generated by the companies. If the investment goes south the equity tranche takes the first loss, but as it is the riskiest tranche interest payments  according to experts are 20%.

In an industry sector that has been used to cheap money from 2010 to 2021, this scrambled rush for loans sees a marked reversal of fortunes. The industry has been facing geopolitical and economic uncertainty plus much higher interest rates which in 2024 has seen takeover volumes down by 50%. Indeed, cash on hand at private equity companies is, according to recent data released, at its lowest mark since 2008 (Global Financial Crisis). Furthermore, experts advise the more influential investors (e.g., state pension providers and sovereign wealth funds) have said they will only commit to new funds if capital in the old funds are released first. 

The private equity industry is valued by analysts at circa USD8 Trillion and has undergone a real cultural change with the balance of power shifting away from the private equity companies to the Limited Partners or LP’s (investors). It is suggested that before too long, these LP’s could cut out the middleman and set up their own in-house private equity companies. This will leave the current players in the market struggling to find the best investment deals to offer a smaller number of investors.

The Financial Markets Got It Wrong Predicting a US Dollar Decline in 2024

As 2024 started many investors, experts and analysts predicted that the US Dollar would decline. However, the greenback, thanks to a very hot US economy, and an inflation problem ensuring the Federal Reserve will not cut interest rates for the time being, means a strong dollar has returned and does not look like it is going away. Furthermore the IMF (International Monetary Fund) has predicted that growth in the United States will grow at a rate of two times that of the remaining members of the Group of Seven, and with geopolitical tensions at a height not seen for decades, the US Dollar is still viewed as the ultimate safe haven.

Many economists and other analysts are predicting that the US Dollar will continue to grow, with one well-known bank suggesting the dollar will continue to increase in value through 2025. The resurgence of the dollar has come on the back of many financial signals pointing to the US economy sidestepping a much anticipated slowdown, with manufacturing continuing to grow and the labour market remaining tight, plus as already mentioned, the forecast of interest rate cuts being put back due to inflationary problems. 

The financial markets have scaled back their bets on an early cut in US interest rates which has resulted in soaring benchmark treasury yields hitting a figure of nearly 5% which has been a major factor in the US Dollar’s appeal. The dollar has also been further driven by the demand for AI (Artificial Intelligence) resulting in massive inflows into the relevant US Stocks. One senior asset manager has been quoted as saying “The dollar is such a high yielder, if you are a global allocator and running your portfolio, what a slam dunk to improve your risk-adjusted returns: buy shorter-term US debt, unhedged.

The US Dollar during times of financial and or political instability is still recognised as the ultimate investor sanctuary, and as such with the current geopolitical turmoil investors have been seeking refuge in the greenback. This was proved last Friday 19th April, where there was a surge of US Dollar buying following Israel’s retaliatory strike on Iran. Indeed, experts suggest that whilst there has been a surge in US Dollars due to geopolitical risks, its strength will probably last well beyond the current conflict. Analysts also advise that high treasury yields coupled with American energy independence will more than likely continue to retain the greenbacks appeal to the financial markets and investors alike.

The Overhaul of Euribor 2024

In October 2023 a new methodology to calculate Euribor (Euro Interbank Offered rate) was proposed by European Money Markets Institute (EMMI)*, where the use of “Expert Judgement” to determine the rate would be discontinued. The consultation paper was found to have broad support and therefore from mid-May 2024 Euribor will be calculated on a different basis. The move to the new calculation will be implemented in a phased manner where panel banks** over a period of six months will be migrated to the new methodology (transaction based) one by one.

*European Money Markets Institute (EMMI) – Along with the introduction of the Euro the EMMI was founded in 1999 by the national banking associations of the Member States of the European Union. The EMMI is an international not-for-profit association, facilitating the smooth functioning of the euro money markets. In July 2019 the EMMI was granted an “Authorisation” by their supervisor – The Belgium Financial Services and Markets Authority (FSMA) – for the administration of Euribor under BMR (Benchmark Regulations of the European Union)

** Panel banks – These are banks (19 banks with top credit ratings and ethical standards) from across Europe that have a place on the panel of the administrator of Euribor (EMMI) for contributing Euribor submissions which are eight different rates based on loans with maturities from one week to twelve months. 

The underlying or core reform dismantles the requirement for panel banks to provide bespoke estimates in certain or unusual circumstances when actual borrowing or lending does not take place. The move will also potentially allow for more banks to contribute to the Euro benchmark which is of course utilised in many products from car loans to mortgages which is valued in the trillions of euros. There are currently three levels that determine Euribor, as outlined below.

·      Level 1 – This consists of contributions based solely on transactions in the underlying tenor (Interest rates for 1 week, and 1, 3, 6 and 12 months), from the prior Target Day, using a formulaic approach provided by the EMMI.

·      Level 2 – This level is divided into three separate or sub-levels,

·     Level 2.1 – This is based on a linear interpolation (helps builds new data points within the range of a set of already known data points), which includes a spread adjustment from level 1 contributions at adjacent defined tenors and is only applicable to the 1, 3 and 6 month tenors 

·     Level 2.2 – This is based on qualifying non-standard maturity transactions (as defined by the EMMI) where the maturity date  falls between two defined tenors and can be used to determine a submission/contribution at the two nearest defined tenors. This level is only applicable to 1, 3, 6 and 12 month tenors. 

·     Level 2.3 – This is based on market-adjusted Level 1 submissions/ contributions from prior fixing dates or historical Level 1 data, and is only applicable to the 1,3,6 and 12 month tenors. 

·      Level 3 – This consists of submissions based on transactions from a range of markets closely related to the unsecured money markets. Each panel bank uses specific data and tailor-made modelling techniques depending on their own funding models.

The new methodology is intended to reduce the operational burden on panel banks who’s current approach is to develop internal processes including a framework for governance for making presumed Level 3 submissions based on expert judgement. Level 3 will, under the new methodology, be scrapped saving panel banks millions of Euros in the costs of meeting this level’s requirements. However, this means that level 2 will be expanded to include additional banks and from a technical standpoint enlarging the starting point of its calculation and redefining the Market Adjustment Factor (MAF) to better reflect perceived credit risks and changes in interest rates. The MAF is calculated based on changes in the closing prices of the ICE (Intercontinental Exchange) Euribor futures contracts for the quarterly months.

Think Tank Advises Rising Sea Levels to Adversely Affect Oil Shipments and Oil Rigs

Due to rising temperatures, rising sea levels caused by melting ice* could seriously erode energy security and disrupt crude oil shipments in countries dependent on oil imports such as Japan, South Korea and China leaving many of the world’s biggest oil terminals vulnerable to flooding, so said researchers from CWR (China Water Risk) on 21st May 2024. Looking back to 2021, an intergovernmental panel on climate change reported that average sea levels could, on current trends, rise by more than a metre or even two metres by the end of the century.

*Melting Ice – In 2023, researchers from the BAS (British Antarctic Survey) reported that low levels of sea ice in and around the Antarctic  could well have been influenced by climate change. Experts advised that during the winter of 2023, Antarctic sea ice was circa 770,000 square miles (larger than Alaska) below average. Elsewhere, a separate report on the Thwaites Glacier (Antarctic) experts found that it is more exposed to warm water than previously thought by scientists. Researchers advise that if the glacier melts it could raise sea levels by two feet.

Experts went on to say that if sea levels rise by one metre 12 out of the top 15 oil tanker terminals would be severely impacted with five of those terminals located in Asia. Furthermore, from a global point of view, it is estimated that up to circa 42% of crude oil exports could be severely impacted from countries including the United Arab Emirates, Russia, Saudi Arabia, and the United States, which in turn could affect 45% of crude oil shipments to China, South Korea, the Netherlands, and the United States.

As a  result of their infrastructure test, CWR confirmed that most low lying bunkering facilities and ports will be negatively impacted by higher sea levels. They confirmed that Asian countries were likely to be hit the hardest, and that they should lead the way in improving port infrastructure to protect them from rising sea levels, but also lead the way in transitioning to green energy. Oil is a massive component in energy security, but oil and gas operations contribute 15% of total energy carbon emissions (5.1 billion tonnes of greenhouse gas) and if the world cannot reduce their dependence on this fossil fuel, far from providing energy security it may end up damaging it beyond recognition.

Bank of England Interest Rates. Will They or Won’t They?

This month on June 20th the Bank of England’s MPC (Monetary Policy Committee) will meet and decide whether or not to keep interest rates on hold. At the last meeting of the MPC in May, interest rates were held at 5.25% for the sixth consecutive month and are still at their highest level since the Global Financial Crisis 2007 – 2009. The Bank of England’s target figure for inflation is 2% and in April it dipped to 2.3% which is a significant difference to March’s figure of 3.2%. 

However, experts in the financial markets had expected CPI (Consumer Price Index a common measure for headline inflation) for April to come in at 2.1%. However an important element in core inflation (does not include figures from food and energy sectors) came in at 5.9% in April down only 0.1% from March. All the above figures are supplied by the ONS (Office of National Statistics).

At the May meeting of the MPC Governor Andrew Bailey indicated that June may see a cut in interest rates though it is not a “fait accompli”, whilst also advising that like other central banks any cut in interest rates will be data driven. In mid-May financial markets suggested that an interest rate cut in June was circa 60% as measured by the overnight index swaps*, but since the release of the April inflation figures in late May that suggestion of an interest rate cut has subsided mainly in part due to sticky service inflation figures.

*Overnight Index Swaps – This is a financial bet on the direction of short-term interest rates and is a type of interest rate swap. In this case, it is typically a fixed for floating swap, where one party pays a fixed rate and receives the floating rate (linked to an overnight index) while the other party does the opposite. The overnight index for sterling is known as Sonia (replaced sterling Libor) and stands for Sterling Overnight Index Average.So will the Bank of England cut interest rates on June 20th? A number of experts suggest that an interest rate cut may not happen as the services sector inflation remains a problem and came in a lot hotter than market analysts predicted. Many experts feel that services inflation remains a critical part of the Bank of England’s thinking regarding inflation and interest rate cuts, and therefore the MPC may well decide to once again hold rates on June 20th.

China to Issue Yuan 1 Trillion (USD 138 Billion) Long-Term Special Treasury Bonds

China’s finance ministry has confirmed that starting Friday 17th May 2024 Long-Term Treasury Bonds with a tenor of 30 years and a value of Yuan 40 Billion will be issued. Bonds with a tenor of 20 years and 50 years will be issued on 24th May 2024 and 4th June 2024 respectively, with the balance of the bonds with a tenor of 30 years being issued in November 2024. This confirms China’s bond announcement in March of this year, with the issuance being the first of its kind for 26 years.

The breakdown of the bonds are as follows,

20 Years  – Yuan 300 Billion

30 Years  – Yuan 600 Billion

50 Years – Yuan 100 Billion

Experts suggest that the Chinese government, which is facing pressure from weak consumer confidence and the on-going housing crisis, is increasing fiscal support to help the economy. The government may well use some of the funds to spend on infrastructure which will be key to hitting their annual growth target of 5%, with some experts suggesting that the boost to Gross Domestic Product could be as much as 1%. Analysts suggest the timing of the bond issue coincides with protectionist tariffs against Chinese goods by the United States, (the latest of which announced 14th May 2024)*, and is intended to offset any impact incurred by such tariffs.

US Protectionist Tariffs – The new measures affect $18 billion in imported Chinese goods including steel and aluminium, semiconductors, electric vehicles, critical minerals, solar cells and cranes, the White House said. The EV figure, while headline-grabbing, may have more political than practical impact in the U.S., which imports very few Chinese EVs.

Experts expect that the Chinese government will use the funds to move the economy away from the investment in infrastructure and property growth model which has caused the increases in debt held by local governments. Interestingly, if compared to a global standard, the Chinese economy has enough room to potentially issue over the next five to ten years bonds to the value in excess of three trillion yuan. Indeed, analysts advise that more long-dated bonds will be issued in the future to strengthen energy and food security sectors, as well as the manufacturing supply chain.

Recent data released showed that aggregate financing (a broad credit measure) shrank for the first time in April by circa Yuan 200 Billion (USD27.7 Billion), down from March, being the first decline since comparable data began in 2017, which reflects a contraction in financing activity. Data shows that in April financial institutions offered Yuan 731 Billion in new loans lower than the project figure 0f Yuan 916 Billion. Experts advise that the issuance of the Long-Term treasury bonds will increase credit expansion in both May and June whilst officials from China’s top commercial banks were recently summoned to the Ministry of Finance to arrange underwriting of the long-term bonds.

United Kingdom Interest Rates: May 2024

Interest rates reached 5.25% in August 2023 and have held steady ever since.

Once again on 9th May 2024, the MPC (Monetary Policy Committee of the Bank of England, BOE), held rates steady at 5.25%. A number of experts and analysts felt that the Bank of England would cut interest rates this time around, but data showed that inflation was stickier than otherwise predicted. A rate cut is still expected this year, but the timing may have just been kicked slightly down the road. Interestingly, the Deputy Governor of the  Bank of England along with external member Swati Dhingra voted for an immediate cut in a 7 – 2 split favouring keeping interest rates steady

However, the Governor of the Bank of England, Andrew Bailey, has given the clearest hint yet that interest rates may soon be cut by indicating that he feels the financial markets have under-priced the pace of easing in the coming months. The governor further advised that before the next meeting on June 6th, there are two rounds of data regarding inflation and wages which will be highly important regarding any rate cut. Governor Bailey went on to say, “It’s likely that we will need to cut bank rates over the coming quarters and make monetary policy somewhat less restrictive over the forecast period, possibly more so than currently priced into market rates”. 

Whilst the governor was not actually confirming that 6th June will see an interest cut saying that date is “neither ruled out or a fait accompli’, this is the first time he has addressed investors/financial markets directly regarding expectations on future interest rate cuts. After the governor’s comments, traders priced in a 25 basis point as 50/50 in June but have fully priced in a cut in interest rates in August. The markets are now suggesting that there will be 59 basis points cut in 2024 as opposed to early suggestions of 54 basis points.

By the end of the second quarter, officials in the Bank of England feel inflation will be down to 2% (Bank of England target) due mainly to lower energy bills. These officials have further advised that they expect inflation to rise slightly throughout Q3 and Q4 but at a gentler pace than previously expected, though they warned geopolitical factors might negatively impact inflation. Interestingly, a number of experts and economists have advised that inflation may well fall below the target figure of 2% by the end of Q2, forcing the Bank of England into cutting interest rates.

What is Basis Trading and How Does it Affect the Treasury Bond Market?

Basis trading is a financial trading strategy regarding the purchase of a particular financial instrument or security (in this case Treasury Bonds) or commodity, and the sale of its related derivative. In this example, it is the purchase of a Treasury Bond and the sale of its related futures contract. In the treasury market, the trade is centred on the price differential between treasury bonds and their associated futures contracts.

From time to time, due to heavy purchasing of Treasury bond futures by insurance companies, institutional investors and pension funds*, the bond futures price rises above the price of the underlying bond. Once this price differential is in place hedge funds take advantage of this price differential and will buy Treasury bonds and at the same time sell corresponding Treasury futures. The upshot of this trade is that by selling the higher priced bonds in one market and buying the cheaper priced bonds in another market, the hedge funds can profit from the price differential. 

*Purchasing Treasury Bond Futures – Asset managers instead of buying actual Treasury bonds quite often prefer to buy futures because there is less upfront cash to pay. 

However, the profits from these trades are very small, and therefore heavy borrowing is required in order to make them more lucrative. Sometimes when there are unexpected episodes or events, this can quite often lead to market volatility leading to potential tragic consequences for the trade leaving the trader no option but to straight away unload all their holdings. This form of arbitrage*, as mentioned previously, requires heavy borrowing, and hedge funds usually borrow from the Repo Market**. It is normal for hedge funds to offer their Treasury bonds as collateral, as the normal practice is to roll-over these loans on a daily basis. Experts advise that these trades can be quite risky due to the amount of leverage involved (on average USD50 for every USD1 invested so 50 times leverage), plus a big reliance on short-term borrowings. 

*Arbitrage – the simultaneous buying and selling of currencies, commodities or securities in different markets or in derivative forms in order to take advantage of the differing prices of the same asset.

**Repo (Repurchase Agreement) Market – In this market money market funds, banks and others lend short-term capital against government securities, in this case US Treasury Bonds. Basically, in this transaction a borrower temporarily lends a security to a lender for cash with an agreement to buy it back in the future at a predetermined price. Ownership of the security does not change hands in a repo transaction.

When the Treasuries market experiences volatility, it can increase the cost of the trade thereby negating profitability, so hedge funds must very quickly unwind their trades in order to repay their loans thereby increasing volatility in an already volatile market.  Such fluctuations can see liquidity drying up and a decrease in the availability of buyers. In such instances* the Treasuries market can literally seize up, and with Treasury bonds being so fundamental to the credit market (and they are risk-free), the US Federal Reserve has had to intervene when the normal functioning of the market has become impaired. 

*Onset of the CoronaVirus – Back in 2020 when the Covid-19 appeared the huge volatility in the markets prompted margin calls in Treasury bond futures, amplifying funding problems in the repo market. Simultaneously, Treasury bond holdings were being dumped by foreign central banks in order to prop their own currencies with US Dollars. This prompted cash bonds to underperform their futures counterparts which is the opposite of the conditions needed for the basis trade to make a profit. It was never fully understood how much basis trading contributed to the turmoil in the market, but the rapid unwinding of positions by hedge funds certainly increased volatility. The upshot was the Federal Reserve promised to buy trillions of dollars of Treasury Bonds to keep markets running smoothly whilst providing the repo market with emergency funding. 

Basis trading subsided after the 2020 debacle but returned in early 2023 due the Federal Reserve monetary tightening policies by raising interest rates a record eleven times in eighteen months, which pushed up yields on 10 year Treasury bonds to circa 5%. On the demand side, this yield (highest since 2007) once again attracted large institutional buyers to buy futures, and on the supply side the Federal Reserve has increased sales of bonds to fund the US Government deficits, which has put downward price pressure on cash bonds. Therefore there is now a sufficient gap between the price of cash bonds and futures to have basis traders up and running again.

Financial watchdogs and authorities are unhappy over these trades, specifically because they are highly leveraged, and the fact that they are direct from one party to another. This means regulation is difficult, plus hedge funds themselves have much less regulation than banks. To this end, the Bank for International Settlements (BIS), the Bank of England and the Federal Reserve have called for closer monitoring of basis trades. Indeed the US Securities and Exchange Commission (SEC) finalised a rule in May of this year (starting June 2024)requiring all private funds to report sudden large losses, margin increases and any other significant changes.

Due to Government Crackdown, Chinese Quant Funds Suffer

 For many international investors who are eyeing the Chinese equity markets with suspicion, the recent and sudden trading restrictions is yet another reason to avoid the markets. Indeed, until February 2024, China has endured a record outflow from the equity market, and due to never before seen crackdowns on the property and tech sectors, foreign direct investment is at a thirty year low. Furthermore, as a result of the Chinese government’s efforts to halt a USD$ Trillion sell-off in stocks the Quant industry*, (once a booming and integral part of the equity market) it has suffered losses and is yet another casualty of government policy.

*Quant (Quantitative) Fund – This is a fund that identifies with automated algorithms and advanced quantitative models together with statistical and mathematical techniques to make investment decisions and execute trades. Unlike other funds (e.g., hedge funds) a Quant fund has no human judgement or intellect in investment decisions, and experts argue that the computer based models mitigate losses and risks related to human fund management. 

Market analysts advise that the new restrictions will require Quant funds to be scrutinised and regulators will demand that any new entrants will have to report trading strategies before actually trading. Apart from sweeping regulations that are harming Quant funds, they have been caught off-guard by government intervention. Due to the five year low on the *CSI 300 index, they took very hard and forceful measures to stabilise the markets, with Quant funds firmly in their sights.

*The Shanghai Shenzhen CSI 300 Index is designed to replicate the performance of the top 300 stocks traded in the Shanghai and Shenzhen stock exchanges and is weighted for market capitalization. As such, it is seen as a blue-chip index for mainland Chinese stocks.

First of all, in early February 2024, the head securities regulator was dismissed and replaced by a veteran known as the “Butcher Broker” due to his previous record of hard crackdowns Experts suggest that Quants were targeted as the authorities were concerned that declines in equities were compounded by Quant funds making short bets and unloading large blocks of shares. Therefore some Quant funds were limited in their ability to undertake short trades, which, combined with shifts in the market, inhibited and stifled Quant funds. 

Analysts advise that a favourite trade for Quant funds is purchasing small cap stocks as they are susceptible to mispricing and the quants computer programmes exploits this opportunity to gain profitability, whilst hedging market exposure by shorting index futures. However, declines in small cap stocks made sure that quant funds reduce holdings and the huge selling triggered losses in the derivatives market known as snowballs*. This caused further panic in the market (known as a quant quake) and index futures were dumped by brokerages as well. 

*Snowballs – A Snowball product is a structured hybrid derivative which pays a bond-like coupon and consists of additional options on basic financial assets, which include underlying assets such as stocks or stock indexes. The word snowball derives from the fact that coupons can be rolled over and coupon pay-outs rely on the underlying asset trading within a certain range. 

Finally the volatility that was in the equity markets impacted those funds (e.g. hedge funds) who had invested in what is known as market-neutral products* and in many cases had leveraged themselves up to 300%, thus forcing them to unwind their positions creating even more havoc in the market which was already going south. This prompted the authorities to prop up exchange traded funds via government-led funds known as the national team, which resulted in a boost for large caps stocks but ignoring the small caps. Data released showed some of the top Quant funds lagging behind the CSI 500 Index (a well-known indicator of the performance of Chinese mid and small cap companies), by circa 12 points for 2 week’s ending 8th February 2024.

*Market Neutral Products – These funds/investments are designed to target returns that are independent of market directions. This is achieved with equal long and short positions in any industry and by investing in equities where the long positions are expected to outperform their peers and the short equities are expected to underperform. Any losses in the short position are offset by profits in the long position.

Following the crackdown on quants the main equity index has risen in nine straight sessions including every day from 19th -23rd February 2024, the longest run of uninterrupted gains in six years. So for now, the strong arm tactics of the authorities are working to stop the downward spiral of equities, however experts wonder if Quant funds will continue operating where there are such arbitrary market interventions. The question is this: will investors be convinced this a one off intervention? Or will the image the authorities have tried to create over the last thirty years that China is committed to a professional and open market be soured?

 The Continuing March Upwards of Private Credit

Private credit can trace its roots back to the 1980’s where companies with strong credit/borrowing records were being loaned funds directly from insurance companies. However, post the 2007 – 2009 Global Financial Crisis, private credit really came into its own as an alternative to bank lending, especially as financial regulators were cracking down on those deposit taking institutions who were involved in risky lending. In today’s market, private credit has become a major contender in the loans market, and a serious rival to banks and similar lending institutions.

As of June 2023, data released shows that global closed-end private debt funds* have assets under management of circa USD1.7 Trillion, whereas as of close of business December 2015 global assets under management were circa USD500 Billion. Indeed, expert money managers suggest that by 2028, due to possible massive shifts in the financial markets, borrowers would flock to the front door of private credit funds, boosting the value of the global private debt market to USD3.5 Trillion. 

Closed-End Fund – This fund is a type of mutual fund, and in order to raise capital or investment, the fund issues a fixed number of shares through a one-time initial public offering (IPO). The shares can be bought and sold on a stock exchange if the fund is quoted, but no new money can be received into the fund once the IPO closes. Access to closed-end funds is only available during a New Fund Offer (NFO).

Open-End Fund – As opposed to a closed-end fund, the open-end fund such as mutual funds and exchange-traded funds (ETF’s) accept new capital on a constant basis and also issue new shares. 

Mutual Fund – This is an investment opportunity where monies/investments are received from a wide range of individuals and pooled together in order to purchase a wide range of stocks, bonds and other securities. Funds are managed by professional money managers and are structured to match the prospectus where the investment objectives are stated.

Private credit is responsible for providing a vast amount of financial resources into a number of differing investment strategies, some of which are outlined below.

1.     Mezzanine Finance – Mezzanine loans or capital can be structured either as subordinated debt or as equity which is usually in the form of preferred stock. Mezzanine financing is recognised as a capital resource which can often be seen as subordinated debt and sits between higher risk equity and less risky senior debt. To facilitate the explanation of mezzanine debt, below are the definitions of senior debt and subordinated debt.

·      Senior Debt – often issued in the form of senior notes and also known as a senior loan, is a debt that will be paid first by the borrowing company. In other words, it takes priority over other unsecured debt and in the event the borrowing company goes into liquidation, owners of senior debt will be the first to be repaid.

·      Subordinated Debt – or as the name implies junior debt, is usually the last type of debt to be repaid. It has a lower status to senior debt and hence the name subordinated debt. Typically, subordinated debt or loans will carry a lower credit rating and will therefore offer a higher return than senior debt.

2.     Venture Debt – Venture debt, sometimes referred to as venture lending, is a certain type of debt lending to venture-backed companies. A venture-backed company that receives venture debt is defined as companies who are at the start-up stage of their existence and rely on venture capital to expand their business. Typically the company has yet to make a profit, and loan size is usually based on the company’s recurring revenue

3.     Distressed Debt – Private credit funds are known a). for buying up corporate debt that is currently trading well under its original value and b). where companies are in difficulties to provide new financing, with a view to make a profit when the company either liquidates or restructures. 

4.     Direct Lending – This type of lending by private credit funds, (aka unitranche loans), are typically a senior term loan (first lien and the least) but can also involve credit lines and second lien loans which are subordinated to the first lien. 

5.     Special Situations –  As the subject suggests, loans in this case are applicable when a special situation or event occurs, and the company’s profitability or growth (a company’s metrics) are not taken into account when lending decisions are made.

A number of experts have asked the question: will private credit stand a sustained protracted recession? Private credit fund managers have answered that in many cases their loans are safer as they are locked in for longer than your standard lending institutions. However, the uncertainty that surrounds the terms in the private credit market means that in a recession no one really knows how far valuations would fall, and as a result would investors in funds that are struggling be able to sell out their positions. 

Regulators in the United States, the United Kingdom and the European Union are looking at expanding regulation in the private credit market. Indeed, regulators in the EU are putting strictures in place which ensure that private credit funds will diversify risk, and will cap leverage, whereby funds use borrowed funds to enhance profits. However, it appears that regulation will remain somewhat opaque as there seems to be a lack of appetite to bring regulation in line with banks and other lending institutions. This of course may reflect the attitudes of many governments, who seem happy to encourage private credit investment that they deem too risky for banks.

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