Better terms and returns swell private credit demand

Aleksei Gorodenkov/Alamy via Reuters Connect

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Private credit in the Gulf is attracting greater interest from borrowers and investors, fund managers say.

For borrowers, high interest rates have depressed mid-sized, private company valuations and make selling equity to raise money less alluring.

And for investors, private credit offers more regular returns than the likes of private equity.

Private credit is non-bank lending. It has soared in popularity since the global financial crisis, topping $2.1 trillion in assets and committed money in 2023, according to an April report by the International Monetary Fund.

Two Abu Dhabi firms – Ruya Partners and Shorooq Partners – are among the Gulf’s leading private credit providers.

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In May, Shorooq announced the first close of its second private credit fund after raising $100 million from investors. Ruya aims to raise $250 million by mid to late 2024, having already raised $150 million at its fund’s first close in May 2023.

The US benchmark interest rate is at a 23-year high of 5.3 percent, up from near zero in 2022. This week, the Federal Reserve says only one rate cut was likely this year, having previously signalled it would make three.

“We’re in a high interest rate environment where equity markets have gone through a period of fluctuations, so people are looking for real cash in their hands,” says Nathan Kwon, a principal at Shorooq Partners.

“This is why there’s a lot of interest [in private credit] from investors who are looking for funds that generate actual distributions, not unrealised gains,” he says.

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Shorooq’s first private credit fund, for example, has a distributions-to-paid-in-capital ratio (DPI) of 0.44, which means it has already returned about 44 percent of the money the fund raised back to its investors – less than three years since launch. A venture capital or private equity fund at the same stage of its lifecycle would typically have a DPI of less than 0.1, says Kwon.

Depressed private company valuations make the cost of raising capital through selling equity more expensive because owners must sell a larger stake to generate the same amount.

As such, despite interest rates at historic highs “if you look at it relative to how much the cost of equity has risen, [private credit] has become a cheaper form of capital,” says Kwon.

“That’s why a lot of savvy CFOs are turning to credit despite high base rates.”

In the GCC only 2 percent of bank lending is to small and medium-sized businesses, the World Bank estimates.

“It’s easy to scale [private] credit and keep on upsizing because the loan facility will be underwritten by a certain asset or cashflow,” says Kwon.

“As the business grows, the value of that asset and cashflow will grow. So then the amount of loan we can give – because it’s a proportion of that asset or cashflow – can also grow.”

Kwon predicts Middle East private credit will “become a very attractive asset class, both from lenders’ perspective and borrowers’ perspective”.

“It’s downside-protected, meaning compared to private equity or VC [venture capital] investments, we’re the first ones in the line to be paid as a creditor.

“The risk-reward profile makes it more appetising to some investors.”

Omar Al Yawer, a partner at Abu Dhabi’s Ruwa Partners, says his firm works with its borrowers as if it were an equity investor.

“We promote them, we bring C-suite executives. We have a lot of covenants with these companies [so] that they see us as a partner,” says Al Yawer.

“We’re not in the business of being vulture lenders because if we give a structure that makes money for us but breaks the company, then chances are we’re going to have two or three investments only and our reputation will be tarnished.”

In May, Dubai’s Propertyfinder borrowed $90 million from California’s Francisco Partners, while this week London-based private credit manager 17Capital opened an office in Dubai International Finance Centre (DIFC).

Risk and regulations

Abu Dhabi Global Market and DIFC have issued regulations enabling entities in these jurisdictions to originate and invest in private credit, a note by law firm White & Case states.

“The UAE is primed to emerge as a relatively untapped well of potential for private credit providers,” the note says. “Common creditor concerns that have arisen in international financings over recent years are not relevant or applicable for UAE-based transactions.”

Should a borrower default, “we have a legal and judicial means we could turn to” says Kwon. “A large part of that is thanks to the international financial zones that the country has established.”