Private Credit in Periods of Economic Uncertainty
In difficult economic times, private credit plays an important role by providing financing to companies and individuals who may have trouble accessing traditional forms of credit.
With public credit markets significantly restricting access to credit, private credit managers with more aggressive mindsets and access to risk-appropriate capital are filling the credit void and taking market share from banks, credit unions and public market credit providers.
Further, with public equity markets turning downward, venture capitalists and private equity firms have reduced their investment pace as a result of valuation mis-matches between public and private market valuations. Investors and management of revenue growth companies may not be willing to accept the newly lowered valuations and are seeking alternative sources of capital until valuations improve.
Let’s take a look at two factors from the macroenvironment that make private credit an attractive option for businesses and investors today:
1. Banks have reduced loan volume and slowed approval processes
We have heard from clients across our group of companies that banks have reduced loan volume and are taking longer than ever to approve loan applications. According to a World Bank report, the world’s micro, small, and medium-sized enterprises have unmet finance needs of approximately $5.2 trillion a year, roughly 1.5 times the current lending market for such businesses. Banks are simply not agile enough to deal with the pace of change brought on by the pandemic and exacerbated by inflation, war, rising interest rates, and supply chain disruption.
2. Venture capital and private equity investors have dramatically slowed the pace and volume of deals
Even though they are seemingly unrelated, public stock market performance affects private investor confidence, especially when it comes to later-stage companies. Even though companies funded today may not seek an IPO for three to five years, there is a very direct link between public market valuations and private equity funding availability. If an investor loses confidence in their startups’ ability to IPO for $1 billion, they also lose interest in funding startups. VC lending was down 35 percent globally in 2022 to $415.1 billion. There was also a sharp decline in M&A activity (down 8 percent) and IPO activity (down 31 percent). We expect that most of these slowdowns were in the last half of the year, as interest rates began to rise. As a result, an even greater dramatic impact is likely being misrepresented in year-over-year data.
Private credit lenders offer speed, certainty, confidentiality, and the ability to underwrite sizable or flexible financing solutions across the capital structure. This makes private credit a great fit for businesses to fill the funding gap that traditional financing has created.
Opportunity for Investors
We believe there has never been a better time to invest in private credit, either as a common shareholder or a yield investor, for three reasons:
1. Private credit is less correlated with public market performance
While private credit is not immune to macroeconomic forces, according to Preqin, the asset class is significantly less correlated to headline risks and offers a diversified source of income and total return potential, along with interest rate protection. As a result, private debt is very well suited for today’s investing landscape.
2. Downturns create higher standards for private credit deals
In today’s down economy with inflation and high interest rates, the principles of supply and demand come into play in regard to credit. With low supply of credit and high demand, credit managers become more selective with the deals they invest in.
As a result, the deals coming into the private credit market are generally from higher-quality businesses whose operating models are agile enough to deal with supply-chain issues, inflation, and other macro challenges more successfully. It stands to reason that these loans will be higher quality and can withstand the challenges of a changing economic environment. In addition, fund managers have the optionality to take action quicker on low credit quality borrowers to prevent losses.
3. A higher interest rate environment can mean higher profits from private credit
When financial communities analyze banks, they usually note that banks become more profitable when interest rates go up. Although unleashed by the constraints of bank rate hikes, private credit has the operating freedom to adjust pricing to reflect what is happening in the wider interest rate environment.
Opportunities with Montfort
Montfort is a publicly traded company (MONT on the TSX Venture exchange). Any investor can purchase a share of the Montfort group, including our four private credit operations. As Montfort’s overall profitability is tied to the profitability of its private credit operations, investors can share in the advantages of private credit in periods of economic uncertainty.
Additionally, investors seeking yield return in the private credit market can invest in one of our yield-oriented vehicles and participate in an asset class normally reserved for institutional investors.
To find out more about private credit, please speak to your financial advisor or visit Montfort.com. For investors interested in our yield-generating opportunities, please contact Matthew Priebe [email protected].