Fixed Income News Australia recently ran an excerpt from Grow Your Wealth Faster With Alternative Assets by Travis Miller, CEO iPartners.

Private credit in the investing space is a growing market where senior secured debt, asset-backed lending, structured and project finance, mezzanine debt and other forms of unsecured debt happen and exist across a wide range of underlying asset classes.

Attractive returns are available in private markets through simply providing the capital quickly, while banks and large institutions can be difficult and slow to work with. It can take three months to be approved for a loan from a bank, whereas private markets can approve a loan within days or weeks.

Here’s what you need to know about private credit in the investing space.

1.     SENIOR SECURED LOANS

A senior secured loan is ranked the highest in the capital structure, so if something goes wrong, you are the first to receive money in any wind-up event. You also tend to get paid the lowest return if there are other more junior forms of debt in the capital stack. This type of loan is also the lowest-risk form of debt from an investor’s perspective. ‘Secured’ means the loan has security attached to it, which means if something goes wrong, the person who loaned the funds has a claim against an asset to recoup their money.

For an investor, a senior secured loan can be a boring investment: you invest the money, and you typically receive monthly or quarterly coupons (interest) and your money back on maturity. Boring or not, there’s still a risk that it might not go well, so you will want to ensure that it is well documented, your charge is registered on the Personal Property Securities Register (PPSR), and the value of any tangible security that can be sold for the recovery of your investment, in the worst-case scenario, is enough to cover the loan repayment and the interest.

2.     UNSECURED LOANS AND THE RISKS

Now we are at the bottom of the capital stack. Unsecured debt is riskier for the investor, and because of this, the borrower usually pays a higher interest rate because this loan has no security. The investor can only expect a positive outcome through the business generating enough cash flow to fund the interest and repay the loan over time.

The downside here is that you have no control – someone else secures the security. However, where you lack legal security through registered charge (that is, a security registered on the PPSR), you do have practical security, even though this is not registered, and protection because the business has excess assets and cash flow, providing structural protection. This would be more than enough to get a full return of capital.

3.     ASSET-BACKED LENDING

An asset-backed loan is at its best when you are lending to a segregated company. This is typically called an SPV (Special Purpose Vehicle), and it is usually a stand-alone company or trust that holds all the assets but does not have the operating costs of a business because it can be a more controlled and predictable outcome for investors.

The risk for investors is greatly diluted by lending small amounts to lots of borrowers, and there are assets sitting behind the loan you have claims too. This is the true benefit of asset-backed lending over a portfolio of assets: your single investment is diversified across lots of small loans.

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