There is a huge credit gap in the mid-market corporates, beyond those served by the corporate bond market and banks. Among the 30,000-40,000 odd mid-market companies in India, less than 200 have access to the debt market via mutual funds, insurance companies, pension funds, etc. Of the total Indian corporate bond market size of ~US$600 billion, only 4-5% of the market is occupied by mid-market corporates and the rest by large corporates.
The credit gap is created on the supply side due to the limited availability of credit from traditional lenders like banks. Banks tend to have rigid, outdated underlying templates, say, a checklist with requirements that may not be relevant to a new-age profitable business. As a result, banks & NBFCs have chosen to focus on retail lending over the past decade.
Further, since 2020, the AUM of Credit Risk Funds (CRFs) has been declining due to increasingly restrictive regulatory mandates & redemption by retail investors. This coupled with preference for higher rated issuers by CRFs led to lesser availability of funds for lower rated investment grade papers.
However, the demand for debt continues to be high amongst mid-market enterprises. Our research indicates that over 90% of these enterprises are profitable. While working capital finance is readily available, medium to long term debt finance for growth is much more difficult to obtain.
These factors have led to the emergence of the Performing Credit space under Alternative Investment Funds (AIFs), which capitalise on the rich spreads offered over liquid bonds
AIFs raise capital from a broader investor base, including family offices, high-net-worth individuals, institutional investors, and foreign investors, thereby expanding the potential pool of capital available to mid-market businesses. This access to diverse funding sources reduces dependency on traditional banking channels, which can be more restrictive in terms of credit assessment and collateral requirements.In a Performing Credit strategy, borrowing entities are profitable and are operating with visible cash-flows, proven and stable business models, over three years of vintage, and a revenue range of INR 300 to 4000 crores. These are mid-market enterprises that are typically rated in the investment grade universe, going up to the ‘A’ category.
In the risk-return spectrum, the Performing Credit space depicts the white space between the low-yield, high-rated space occupied by debt mutual funds and high-risk space favoured by special situation, distressed, and venture debt funds. This space typically yields 8 – 16% gross returns and offers superior risk-adjusted returns.
The entities in the Performing Credit space can issue bonds to AIFs. Often for mid-market enterprises, such an issuance may be the entity’s maiden capital market issuance and rating exercise.
It is therefore clear why AIFs could be a preferred route of capital raising for mid-market enterprises. However, the success of Performing Credit AIFs will also depend upon the value such funds generate for investors. By investing in Performing Credit via a pooled and diversified investment vehicle, investors may:
- Enjoy a risk premium that is much higher than the expected loss of the portfolio.
- Take exposure to several sectors with low correlation to each other.
- Access an untapped and growing market through specialised fund managers that are better placed to source such opportunities and underwrite the risk.