What is Alternative Credit?
Alternative credit, also known as private credit, is a term used to refer to capital that private funds loan to businesses through direct lending or structured finance arrangements. Borrowers are typically small and mid-sized businesses that lack credit ratings and do not issue securities traded on public markets.
Who Benefits from Alternative Credit?
Private credit provides much-needed capital to small and mid-sized companies, enabling business owners and entrepreneurs to hire and retain talent, invest in long-term projects, conduct research and development, and build facilities. Private credit also serves as a stabilizing force for the U.S. economy, aiding businesses in all market environments in contrast to banks and other traditional lending institutions, which historically have withdrawn or ceased to issue financing during periods of market stress such as the onset of the COVID-19 pandemic or the Global Financial Crisis.
As an example, following the Global Financial Crisis, changes in bank capital requirements caused many banks to significantly reduce lending to small and mid-sized businesses throughout the country. Alternative credit funds provided a lifeline to U.S. businesses by filling this gap. Today, the $1.5 trillion private credit market provides capital to businesses of all sizes in every industry.
By the Numbers: How Does Alternative Credit Benefit Your Community?
The income generated by private credit funds helps the pensions, endowments, and foundations that invest in these funds to support beneficiary retirement plans, academic scholarships, and numerous charitable causes, respectively.
How are Alternative Credit Advisers Regulated?
Advisers to private credit funds are registered with and regulated by government agencies, such as the Securities and Exchange Commission (SEC) in the U.S. These funds and their managers are held to the same robust disclosure and reporting regulations as other alternative asset managers, preventing fraud and mitigating systemic risk.
Alternative Credit is Stable
Alternative credit providers are not subject to liquidity risk. Credit funds receive capital from sophisticated investors who commit their capital to the funds for multi-year holding periods. The long capital commitment periods – reflected in fund partnership agreements – prevent runs on a fund and provide long-term stability for the fund and its borrowers.
Private credit funds are not implicitly or explicitly backstopped by the federal government. Therefore, taxpayers are not liable in times of stress.
Alternative credit presents no risk of contagion to other funds or the economy. If a credit fund fails, the losses are borne by that specific fund’s manager and investors and do not impact investments in other funds or otherwise ripple across the broader financial system.
A 2020 Government Accountability Office report found that private funds' lending activities have not threatened financial stability. Private credit default rates are generally limited due to the strong debt structure, contractual provisions that minimize default, and underwriting that protects the fund, as lender, and the sophisticated institutions that are invested in the fund.
MFA, in conjunction with Proskauer, published a white paper highlighting that private credit poses no significant threat to financial stability, and provides an overall stabilizing effect on the U.S. economy:
Private Credit in the News