India’s private credit market is booming, drawing a host of new players into the segment, but experts say this trend has raised concerns about the potential mispricing of risk in the market.
Sample this. Ink maker Hubergroup is raising Rs 1,500 crore debt, but the deal, which is on its last legs, is set to happen at an internal rate of return of 12.5% for the lender, down 300 to 400 basis points than such deals in the recent past. The reason: intense competition among non-banking financial companies and private credit funds to outbid each other, leading to a drop in pricing of such deals. There are many other such examples.
A number of players such as Vivriti Asset Management, UTI Alternatives, Neo Asset Management, and others have launched private credit funds in recent months and global players such as Cerberus Capital Management plans to expand its private credit portfolio in the country.
Data published by markets regulator Sebi in the second half of 2023 show at least 11 new alternative investment funds have registered with it for credit/special situation orientation and five are in the process of registration. Nine funds announced new fundraises in excess of $2 billion in the second half of 2023, consulting and auditing firm EY said earlier.
Private credit deal flow into India in 2023 was higher than 2022, both by deal count and value. In CY23, there were 108 deals totalling $7.8 billion versus 77 deals of $5.3 billion in the previous year.
“For established players, securing attractive deals has become more difficult as new entrants aggressively pursue opportunities, often willing to accept lower returns to gain market share,” Ashutosh Ojha, managing director at Neo Asset Management, said. This can lead to compressed margins and a potential race to the bottom in terms of pricing, Ojha said.
Neo Asset Management, founded by former Edelweiss CEOs Nitin Jain and Hemant Daga, recently announced the final close of its Special Situations credit fund, raising Rs 2,575 crore in the strategy.
Additionally, the increased competition may lead to more relaxed underwriting standards as firms strive to differentiate themselves, potentially increasing the risk of defaults and losses. “At Neo, we strive to adopt thorough due diligence processes to maintain prudent risk management practices amidst heightened competition,” Ojha said.
Ankur Jain, managing director, credit strategies at InCred Alternatives, said the number of funds with limited track record continue to enter this space. “This can cause mis-pricing of risk which may not be healthy in the long run. In a limited way, we are observing that already,” Jain said.
That’s the reason why the Reserve Bank of India’s latest Financial Stability Report raised multiple red flags, calling the private credit market a systemic risk as many of the non-bank lenders are connected with the broader banking system. One, this category comprises riskier borrowers than counterparts in the traditional lending space and could generate outsized losses. It means that the regulator is concerned that a credit collapse of these borrowers can have implications for the broader banking system.
RBI also thinks that the private credit structures are becoming complex, adding multiple layers of leverage. These complex, multi-layered lending structures and excessive leveraging have brought major financial crises, including the 2008 global meltdown. What is also worrying the banking regulator is the opaque nature of the market and the difficulty in getting data.
Jain of InCred said entry barriers are coming down in private credit, which is also helping managers to launch new funds. “Unlike private equity, where fund managers have to wait for at least five years to show a good performance, in performing private credit, the gestation period is relatively quicker at one or two years. Hence, they can launch one new fund every year,” Jain said.
Regulatory capital to start a private credit fund in AIF (alternative investment fund) format is minimum Rs 10 crore unlike in the NBFC or mutual fund space. Domestic high net worth individuals and family offices are chasing higher yields on the fixed income side. “Private credit provides that avenue. Plus distribution engines in the form of wealth management firms provide private credit fund managers avenue to reach out to these yield hungry investors,” he said.
Ojha of Neo Asset Management said increased competition has driven innovation in deal structures and terms, offering borrowers more options and potentially better rates. New entrants bring diverse expertise and strategies, which can enhance the overall quality and variety of financing solutions available.
Raghunath T, head of credit, Vivriti Asset Management, said the competition has increased in certain pockets of the private credit market like high yield, special situations, and structured credit. “However, there is a large untapped market which is providing growth capital to mid-market corporates that do not have access to traditional financing lines,” Raghunath said.
However, opportunities in this segment require differentiated credit origination, underwriting and monitoring skills, which a house like Vivriti possesses, he said. Vivriti is looking to raise Rs 2,000 crore private credit fund to invest in mid-sized companies with 15-16% pretax returns.
