After the financial crisis, capital requirements for banks were significantly tightened, and riskier loans now require more capital to be held. As a result, banks have become more selective in their lending, prompting companies to turn to private credit more often. This shift also offers advantages for entrepreneurs: loans can be more tailored to their needs, and private credit provides greater flexibility and certainty compared to traditional bank financing.
For investors, private credit presents an opportunity to support these entrepreneurs while also enhancing portfolio diversification and potentially achieving higher returns than those offered by publicly traded corporate bonds.
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"}},{"title":"2. Mezzanine Financing","richBody":{"value":"Mezzanine financing is a hybrid loan that combines features of both equity (ownership) and debt. Companies typically choose this option to finance mergers or acquisitions. Mezzanine loans carry higher risks than traditional loans, as the borrowing companies often already have significant levels of debt. In return, investors can expect higher interest rates, and in some cases, the loan (or part of it) can be converted into equity.
"}},{"title":"3. Distressed Debt","richBody":{"value":"Distressed debt involves providing loans to companies facing financial difficulties. These may be businesses on the brink of bankruptcy or already undergoing a restructuring process. This form of private credit requires an active approach from the investor, along with a solid understanding of legal frameworks. The core idea is that the investor helps steer the company through turbulent times, ultimately restoring its prospects for the future. If successful, the potential returns can be substantial. However, these opportunities also come with significant risks.
"}}]},{"componentType":"paragraph","richBody":{"value":"In addition to the three main types, there are several other options within private credit. One example is senior secured loans, where the loan is backed by company assets such as real estate or inventory. In the event of bankruptcy, the lender has priority over other creditors. As a result, senior secured loans carry lower risk compared to mezzanine loans, largely due to the high level of collateral security.
A relatively new form is the unitranche loan, which combines elements of both senior and mezzanine debt. Another option is asset-backed lending, where the loan is also secured by tangible assets like property or inventory.
"}},{"componentType":"sectionTitle","title":"High Corporate Debt Levels"},{"componentType":"paragraph","richBody":{"value":"While private credit offers many opportunities, it also comes with elevated risks. Companies seeking private loans often already carry significant debt, and typically lack a credit rating from agencies like Moody’s or S&P, either due to their size or the cost of obtaining a rating. This makes it harder for investors to assess their creditworthiness.
Moreover, private credit is not as clearly defined as traditional asset classes like equities or bonds, making it a less transparent and more complex investment. This lack of clarity can leave investors vulnerable to surprises, a concern previously raised by regulators such as De Nederlandsche Bank (DNB).
Due to the absence of a secondary market and limited comparable transactions, valuing private credit can be difficult. Illiquidity is a key risk, as investors typically must hold the debt until maturity.
"}},{"componentType":"sectionTitle","title":"Differing risks"},{"componentType":"paragraph","richBody":{"value":"Due to the various forms of private credit, the associated risks can vary. Loans secured by assets such as real estate or inventory are generally less risky than distressed debt. As an investor in senior secured loans, you are positioned higher in the capital structure than with mezzanine loans, giving you priority in the event of bankruptcy. Some experts even argue that certain forms of private credit carry no more risk than high-yield bonds, as the terms of the loan are tailored to the specific needs of both borrowers and lenders.
More and more companies are strategically using both public and private capital markets to secure financing. This broader range of financing options to support growth allows companies to better adapt to market conditions, while also strengthening their capital structure. This, in turn, reduces risk for investors.
In some cases, a European member state may partially guarantee credit losses on subordinated loans. This support measure was introduced to encourage private credit funds to finance small and medium-sized enterprises (SMEs).
Furthermore, now that the interest rate peak cycle of central banks worldwide appears to be behind us, the financial pressure on companies is expected to ease. Nevertheless, in recent years there have been few defaults or repayment issues, according to data from the Lincoln Senior Debt-index. The default rate in the direct lending market steadily declined over the past year and stood at approximately 2.5% in the second quarter of 2024, down from a peak of 4.5%.
"}},{"componentType":"sectionTitle","title":"Conclusion"},{"componentType":"paragraph","richBody":{"value":"Private credit offers investors a way to diversify their portfolios and support businesses that may not have access to traditional bank financing. It also presents the potential for higher returns than corporate bonds. However, this comes with higher risks: companies often carry substantial debt, and the lack of a secondary market means investors must hold the debt to maturity, making it an illiquid investment. Given the wide range of private credit structures, it’s important to understand the specific risks and opportunities of each type and to diversify within the asset class where possible.
ING collaborates with Blackstone and Goldman Sachs to offer Private Banking clients access to senior secured European direct lending funds.
The value of your investment may fluctuate. Past performance is no guarantee of future results.
"}},{"componentType":"sectionTitle","title":"Disclaimer"},{"componentType":"paragraph","richBody":{"value":"Investing involves risks and costs. You may lose all, or part of your investment. Learn more about the risks of investing and how to limit them. Also, read the General Terms and Conditions for Investments. ING integrates sustainability into investment decisions by applying ESG criteria, excluding sectors like fossil fuels, and targeting investments that meet specific environmental or social impact thresholds. Learn more about our Sustainable Investing policy, including measurable outcomes, at ing.nl/ESG.
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