Indian private credit space - The hunt for yields

·       While the private credit space is relatively new to India, globally the sector has multiplied ten-fold since Global Financial Crisis (GFC) and is expected to hit USD 3.5 trillion + by 2028.  Post GFC, Commercial Banks (under heavy regulatory surveillance) changed gears from unbridled enthusiasm to risk aversion and paved the runway for private credit leading to its explosive growth.

·       Similar development is playing out in India. Banks faced barrage of ‘Non-performing loans’, which took years to clean and turned them inherently cautious/borderline paranoid in lending to certain areas. Funding need for these areas (like growth capital for new economy companies, mezzanine/acquisition financing, structured finance, certain Infrastructure areas, special/distress situations, sensitive sector lending) has been plugged by private credit which has the necessary approach and risk framework to tackle these areas.

·       This is a welcome development given that Indian Banks should not have been primary source of capital to these specialized lending requirements to begin with given these entail enhanced due-diligence, deeper sectoral awareness, more complicated security packages. Managing these transactions require nimble footed decision making/risk resolution and a more ‘hands-on’ management style to deliver a bespoke funding solution to the client. It was unfortunate that in the past Indian Banks were pushed/voluntarily entered into such areas in absence of a more sophisticated capital pool.  

·       Falling yields on traditional debt instruments, expensive equity valuations and peaking alternate asset prices have further aided the flow of ‘risk-on’ capital to this sector. With maturing investment sophistication amongst family offices/HNIs and Institutional Investors, the area is expected to grow further.

·       Regulatory framework has been largely conducive except for a few niggles. A much needed regulatory waiver required is on mandate that a Company which has issued listed debt continues to issue only listed debt securities going forward. This is an onerous restriction which is more of regulatory need for wider equity markets. Such a regulation would in-fact deter the Companies tapping listed debt space and further defer the deepening of debt markets.

·       On issue of co-lending/on-lending, it might be more prudent for Banks to play a complementary role rather than compete with AIFs for business and continue to operate in prime credit space. The risks of private credit are akin to private equity - opaque valuations/ratings and systemic risks may take time to come into full view. While the direct risk is being borne by right set of Investors with deep pockets instead of tax payer/retail investors, the indirect impact in case of a fallout could be severe. Hopefully the growing competition does not cause a repeat of scenario that played out during Bank lending boom, which didn’t end well.

·       Till now, the AIFs seem to be pricing credit right and have maintained the much needed discipline while operating in this high yield space. With a new private credit fund entering the Indian market every other day, the intermediary market is also expected to take off. As the market expands, the sector would need intermediaries who can complement the limited origination capacity of credit funds. But these intermediaries would also need to be more sophisticated and have better appreciation of credit/structuring aspects and sector knowhow to facilitate transactions.