After IL&FS & Covid, NBFCs have ceded space to pvt credit funds: N Dhedhi

Nilesh Dhedhi, head of structured credit, Avendus Finance explains the nuts and bolts of these investment vehicles which are aimed at sophisticated investors

Private credit funds, a source of non-bank debt capital for private companies, are pegged to grow exponentially over the next five years. Nilesh Dhedhi, head of structured credit, Avendus Finance, in an interview to Samie Modak, explains the nuts and bolts of these investment vehicles, which are aimed at sophisticated investors, Edited excerpts:

What is a structured credit fund? What are the latest trends in this space?

Structured credit can largely be described as mid- to high-yield (broadly in the range of 12-18 per cent) non-bank lending to private companies in the form of debt or debt-like instruments.

Private credit funds are pooled investment vehicles that typically offer flexible and bespoke solutions to companies or entrepreneurs in consonance with their specific needs which might not be met from traditional debt lending institutions, either due to very specific lending norms, regulations, differing perspectives on industry and business risk. Examples include acquisition funding, private equity buyouts by promoters and right-sizing the capital structure and repayments linked to prospective cash flows or liquidity events.

Structured credit funds can have different strategies to enhance risk-adjusted return in the form of either a very specific strategy or a theme or targeting opportunistic and niche strategies. Avendus Structured Credit Fund is a performing credit fund – where we lend money to companies that have strong differentiated business models managed by high quality promoters and management and are backed by marquee private equity investors.

What could be the assets under management (AUM) of the domestic structured credit funds industry?
 

According to an EY report, the estimated annual opportunity for private credit could be between $15 and $31 billion by 2026. There is a significant polarity in the Indian credit market. While banks lend to companies for very specific end use under specific criteria, public markets generally look at companies having rating AA- and above. On the other hand, companies where the requirement needs to be flexible or customised, there aren’t many players catering to this market. Earlier non-banking financial companies (NBFC) used to target this segment, however post IL&FS and the Covid-19 pandemic, this space has been dominated by private credit funds.

What role do structured credit funds play in the overall financing ecosystem?
 

A structured credit fund offers companies and promoters bespoke financing solutions that may not be available or cannot be solved for with traditional forms of capital from banks, NBFCs, mutual funds or the equity ecosystem. These may include financing for stake sales; buyout financing, growth financing, acquisition financing, capex financing, bridge to equity. It expands the entire capital structure spectrum and allows customised capital for the type of need.

What are the regulatory changes needed to develop the structured credit market?
 

One of the key factors affecting domestic investors' participation in private credit funds (AIF structure) has been the tax differential compared to other investment categories such as mutual funds or other listed debt products. AIF are taxed at marginal return irrespective of the holding period compared to long term capital gains tax of 20 per cent with indexation (effectively 13-14 per cent) for investments held beyond three years for mutual funds (MF) or listed debt products. This results in increased returns expectation from investors seeking to diversify their portfolios across different credit investment strategies.

What are the key headwinds and tailwinds for the segment?
 

As the economy grows at a high rate over the next few years, there will be an increased need for credit across the spectrum to meet financing requirements of mid and large companies. Further, major regulatory, legislative and market reforms including a creditor friendly framework and major economic reforms have attracted significant long-term offshore capital from large institutions and credit players, especially for special situations. While India continues to show resilience as it faces headwinds from ongoing and new global developments, a depreciating currency and elevated inflation, a stronger US dollar and rally in US bond yields further dilutes the case of emerging market investments for a narrowing risk-reward differential. During a high growth stage with increasing competition, sometimes the credit market could also see the risk of getting mis-priced risk as all players focus on growing the book.

How’s Avendus’ portfolio constructed?
 

Avendus has been an active participant in the structured credit or performing credit business for over a decade and has executed over 60 deals over the last five years. Deep domain knowledge, proprietary access across the Avendus platform, an ability to conduct private equity-type diligence for credit and deal structuring capability with an ability to control exit outcomes has helped derive desired outcomes. All nine transactions from Avendus Structured Credit Fund – I have been fully exited and returned within four years with a gross portfolio IRR of 18 per cent. This has led to a larger fundraise for Avendus Structured Credit Fund – II with a target size of Rs 1,000 crore.