How Can Investment Professionals Capitalize on Private-Credit Firms’ Expanding Role in Tighter Lending Markets?

The global financial markets have changed in the last 15 years. Here in the United States, lending markets have tightened due to federal regulations, hoping to avoid the crisis of 2008. Now, small to mid-sized banks are stricter with their lending practices, leaving a vacuum in the market for private credit firms to fill.

How Can Investors Take Advantage of Private Credit Firms’ Rise?

The rise of private credit firms provides opportunities for investors like you. Here are five ways you can uilize private lenders for your financial gain.

1. Investing in Private Credit

The first opportunity you have is to invest cash in private credit funds. These lenders finance debt for private companies even if they’re not investment grade. Private credit investments can lead to higher yields because they lend to riskier borrowers who aren’t on the public debt market. These companies must pay higher interest rates, thus giving you higher returns on your investment.

Another reason to consider investing in private lending is its low liquidity. Low-liquidity investments often lead to higher yields because investors demand higher interest rates in exchange for less cash. There are risks involved with low-liquidity assets, but the returns are enticing.

2. Finding Lucrative Sectors

Private lending has significantly expanded in the real estate market over the last decade. However, there are other industries private credit has spread into. For instance, you’ll see private lending companies involved with media and entertainment, financial services, tech startups and health care companies. These investment opportunities provide different ways to diversify your portfolio.

Focusing on one or two sectors may be helpful. Narrowing your attention helps you gain expertise because you can specialize in a particular industry and better manage your risk. Find a sector you want to learn more about that provides solid returns and is a worthwhile risk.

A popular industry for credit professionals is health care. People need health services regardless of the economy, making this sector safer than others like tech. Plus, the senior population is growing and will increase the demand for health care. Census data show the older population grew faster between 2010 and 2020 than in any decade since the 1880s. Private lending opens the door to future lucrative returns.

3. Searching for Distressed Debtors

Private lenders lend money to businesses that investors might not consider investment grade. Additionally, they purchase debt from banks or fellow lenders if the financial institution can no longer afford to carry the debt. Therefore, the company must consider selling off consumer loans to someone else, opening an opportunity for private credit funds.

Private lenders typically change the company and its debt terms when they take on debt. For example, they may force the business into bankruptcy to liquidate their assets and pay the money back. Private lenders may also impose high interest rates or restrictive covenants. These terms help you get more out of your investment.

4. Considering Mezzanine Debt

Private credit funds purchasing debt have numerous options on the table. Typically, investors look for senior debt because it’s the first money companies repay if they go under. Junior debt is riskier because it doesn’t have collateral. Senior debt may produce a low yield, whereas junior debt is too dangerous. So, how can you find a middle ground?

The happy medium between senior and junior debt is mezzanine debt. Companies typically use this type of debt for buyouts or corporate acquisitions. Mezzanine debt is a lower priority than senior debt when a business defaults, so you may see yields between 12% and 20% on average. You assume risks with mezzanine debt because it’s not easy to sell and the debtor’s assets may be limited.

5. Advising Private Lenders

Private credit provides investment opportunities with risks and high-yield debts. However, investment isn’t your only chance to enter the sector. Investment professionals can also join the private lending world through advisory services. Private credit funds worldwide require experts to ensure they’re making sound decisions.

For example, private lenders need investment professionals well-versed in risk management. Experts help private credit companies examine interest rate fluctuations, debt restructuring and repayment terms. Research skills are also valuable when doing due diligence. You need to scrutinize the borrower’s financial strength and what the loan terms are.

Why Does the Lending Market Favor Private Credit?

The world looks much different now than it did 20 years ago. One of the most significant changes for investors has been the lending market and its tightening. Why have these changes favored private credit?

Changes in Risk Assessment

Twenty years ago, lenders were much looser in their practices. For example, banks recklessly lent money to families buying houses in the early-to-mid 2000s, leading to the mortgage crisis. Many homeowners couldn’t afford to follow through with their loan terms, leading to a high rate of defaults. Banks nationwide tightened their lending practices to avoid a repeat of the economic crisis.

Laws and Regulations

During the economic crisis, the federal government instituted the Dodd-Frank Act to regulate America’s financial system. After implementing the law, lending became much stricter for most companies.

Securing loans became more challenging because lenders now scrutinize your credit score, creditworthiness and debt-to-income ratios. Tighter regulations have left some debtors out, with private credit funds offering them a hand.

Economic Unease

The 2008 financial crisis hasn’t been the only cause of economic uncertainty. In the past three years alone, you’ve seen a pandemic, supply chain disruptions, and conflict between Russia and Ukraine. These global events often lead to banks tightening their standards and becoming less likely to lend. Private credit funds fill the void by attracting investors looking for high-yield opportunities.

Using Private Credit for Investment Gains

Private lending used to be an idea only a handful of investors became involved with. Nowadays, it’s a popular investment opportunity for investment professionals to capitalize on, considering today’s lending market.

You’ve seen many changes in the last decade as banks become weary of lending money and acquiring debt. Now, you can use private credit to your advantage for investment gains. There are risks involved, so you should carefully research your investment options.