Historically, banks have been the main source of funding for businesses.
The 2008 Great Financial Crisis changed this practice. Risk was no longer
tolerated, and lending practices drastically rotated into stringency. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. This prevented banks from participating by imposing heavy regulations.
Smaller regional banks stepped into the role, becoming new partners to
start-ups and other businesses needing short-term loans or funding. As
quantitative easing came to an end and the Fed started raising rates, the
banking landscape changed even more in preparation for a recession. After the failures of Silicon Valley Bank, First Republic, and Signature Bank, federal regulators took another look at their uninsured deposits and enforced even more regulatory practices in an effort to keep them stable.
The reduced lending activity by banks has had several implications for
investors looking at private credit and alternative lending markets. Private
credit is taking the spotlight currently, here are a few reasons why:
- Increased Demand for Private Credit - With banks scaling back their lending activities, there is increased demand for private credit from borrowers seeking financing for various purposes. This includes commercial real estate development, corporate expansions, and small business operations. It has increased opportunities for private credit investors to fill the gap left by traditional lenders, generating attractive risk-adjusted returns.
- Higher Yield - As banks tighten their lending standards and reduce the supply of credit, borrowers may be willing to pay higher interest rates to access financing from alternative sources such as private credit funds, direct lending platforms, and specialty finance companies. This could lead to higher yields for investors in private credit vehicles.
- Diversification Benefits - Investing in private credit can provide diversification benefits to investors by offering exposure to a wide range of credit assets that may have a low correlation with traditional fixed-income securities and equity markets. Private credit investments often include senior secured loans, mezzanine debt, distressed debt, and specialty finance opportunities. These can help mitigate portfolio risk and enhance overall returns.
- Enhanced Due Diligence - With the proliferation of private credit investment opportunities, investors should conduct thorough due diligence to assess the creditworthiness of borrowers, evaluate their underlying collateral, and understand the structural features of the debt instruments. Rigorous underwriting standards and ongoing monitoring are essential to managing credit risks and preserving capital in private credit investments.
- Structural Advantages - Private credit investments often offer structural advantages over traditional bank lending. Greater flexibility in terms of loan covenants, repayment schedules, and collateral requirements allows private credit investors to tailor financing solutions. Value can be captured through customized deal structures.
- Regulatory Considerations - While investing in private credit can offer attractive returns and portfolio diversification benefits, investors should be mindful of regulatory and compliance requirements governing alternative lending activities. Regulatory changes or updates in tax policies can impact the risk-return profile and make adjustments to strategies necessary.
Another consideration to remember is that the current inverted yield dramatically reduces the incentive for banks to lend. The Fed has been working to increase interest rates to invert the yield curve, hoping to keep banks from lending, slow the economy down, and lower inflation.
Overall, the reduced lending activity by banks has created opportunities for investors in private credit and alternative lending markets. Capital can be deployed strategically, generating attractive risk-adjusted returns and
diversifying portfolios. However, investors should carefully evaluate the
risks and opportunities associated with private credit investments and
strongly consider teaming up with a manager who understands this -
implementing robust risk management practices to navigate the evolving
market landscape.
Vineyard Global Advisors offers 13 fee-only, actively managed,
including hedged and long-only investment strategies via
separately managed accounts.
This includes private credit options for accredited investors.
Contact Us to learn more.
Learn more about the advantages of Separately Managed Accounts that
include:
- Customized investment portfolios
- Tax smart planning
- Insight and transparency
- Professional management
- Risk-managed diversity
“The way risk is handled can have a
substantial impact on an
investor’s ultimate success. Our approach
for all Vineyard strategies involves
applying layers of protection as needed in
response to changing market conditions,
with the goal of providing the most
protection during times of significant
market deterioration.”
Vineyard Global Advisors-Our philosophy
