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BLOG. 2 min read

Understanding the Role of Leverage in Private Credit

As we explore the findings of our "Financing the Economy 2023" survey, conducted in partnership with the Alternative Credit Council, our report showed some interesting results related to leverage—from the typical providers of leverage to the terms in which leverage is provided, to the risk management practices of fund managers and leverage providers.

The use of leverage by private credit funds is subject to security from policymakers and regulators, with the most commonly used forms of leverage being subscription line financing, borrowing against portfolio assets and cash flow management facilities. Subscription line financing borrows against capital commitments from investors, while borrowing against portfolio assets and cash flow management facilities are secured against fund assets.

These leverage trends are seeing two notable impacts in the higher rate environment we’ve discussed previously. First, as private credit funds increase the returns from their lending activity, the higher rates reduce the need for them to use leverage to meet return targets. Second, higher rates translate to higher finance costs and lower risk appetite. Additionally, investors who may have previously preferred unleveraged strategies have shown more willingness to consider those strategies.

Reporting is a major consideration for private credit funds borrowing against portfolio assets and cash flow management facilities. After a facility is activated, finance providers need regular reporting and updates on the portfolio, such as the latest valuation of the assets and relevant credit metrics and performance. This reporting ensures the finance providers have transparency of their investment. Leverage providers generally consider private credit funds to be attractive borrowers, as lending against a diversified pool of assets provides good downside protection.

In addition to the expectation of robust reporting, finance providers also tend to undertake a high level of due diligence and credit analysis on the businesses that make up a loan portfolio. Bank lenders also require regular reporting, with disclosures similar to those made by private credit funds to their investors.

To learn more about how the high-interest rate environment is impacting the private credit space, download the "Financing the Economy 2023" report. For more discussion of this report, read our "Achieving Resilience in a High-Interest Rate Environment" and "Capital Deployment Opportunities for Private Credit Managers" blogs.

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