Where Does Private Credit Fit? Follow the Cash

More than two decades ago, a client signed a 30-day factoring contract with us. The client is still with us, and the contract is still 30 days.

That is one facility in one of our five lending verticals. Behind it, cash has moved continuously: invoices purchased, invoices collected, and funds advanced again the following week.

Our other four verticals generate cash on different schedules. Asset-based revolvers draw and repay as borrowers’ working capital needs change, while term loans follow agreed repayment schedules. Commercial SME Finance and Lender Finance facilities earn interest on lending secured by other lenders’ loan portfolios. Opportunistic Finance facilities are structured around the realizable value of secured assets and asset pools. Together, these activities support cash generation across the portfolio throughout the month.

Most income-producing assets pay interest less often. A Government of Canada bond pays interest twice a year, while many dividend-paying stocks pay quarterly. A private credit fund lending on three-to-five-year terms usually pays quarterly. In each case, income arrives on the schedule the underlying assets set.

The first piece in this series asked whether a private credit allocation adds a genuinely different return driver to what an investor already owns. This piece takes up the practical follow-on: what keeps it producing income each month?

In our case, profits can be distributed monthly, while capital returning through borrower repayments is available to be lent again.

Two flows inside the fund

Two flows move through the portfolio. The first is principal. Borrowers repay advances, receivables are collected, facilities revolve, and capital becomes available to lend again. The second is income, primarily the interest and fees earned while that capital is in use.

Principal coming back gives the fund cash to redeploy. That repayment is a return of capital, and the month’s result is built from the interest and fees earned alongside it. Separating the two flows explains how the fund can distribute a month’s profit while keeping the capital that produces the next one.

Short duration keeps that capital moving. The portfolio’s weighted average duration is approximately seven months, within a target range of six to nine. The factoring book collects approximately every 50 days, and term facilities are generally written at around one year, with a renewal decision at the end of each.

Spread across the book

The fund targets 80 to 120 active credit facilities and, at time of publication, currently holds approximately 103, across Invoice Factoring, Asset-Based Lending, Commercial SME Finance, Lender Finance and Opportunistic Finance. Payment and collection dates fall at different points in the month, and the verticals carry different weights in the book. The month’s result is the sum of activity across many borrowers, and no single repayment decides it.

Factoring is the easiest of the five to picture, which is why it is worth using as the illustration. Erica Axani, our Executive Vice President and Chief Risk Officer, described it this way during a recent US webinar:

“Once you start buying the client’s invoices and funding them month over month, week over week, it starts to get very sticky and they get very used to that flow of cash.” Erica Axani, Executive Vice President and Chief Risk Officer

Factoring is one vertical among five, and the stickiness Erica describes is specific to it. The wider point holds across the book: a borrower collects an invoice, repays an advance, generates another receivable and draws again, while elsewhere a revolver is redrawn, a term loan makes its payment, and a lender-finance facility earns interest against a loan book that is collecting on its own schedule. Those cycles together keep capital moving and income accruing throughout the month.

What “all monthly profits” means

The fund distributes all monthly profits, and investors may elect to leave them to accrue.

The administrator calculates the net asset value monthly and determines the month’s result. The distribution follows what the portfolio earned in the period, so the amount varies from one month to the next.

Inside that sits a question about what counts as earned. Payment-in-kind interest accrues onto a loan balance without arriving as cash, and a book carrying a large amount of it can report a profit it has not collected. Historically PIK has been under 5% of the portfolio, which keeps the month’s result close to the month’s cash.

Historically, the annualized distribution rate has been above 8 percent. That history describes what the portfolio has produced through interest and fees over time. Each month stands as its own result, and the strategy carries credit risk.

Receive it or leave it in

An investor may elect to receive the distribution in cash or allow it to accrue. The election changes how the return reaches the investor. The portfolio underneath is the same either way.

For an investor with regular cash requirements, twelve payments a year can sit closer to the obligation than a semi-annual coupon or a quarterly window, and it reduces the need to hold cash idle between payment dates.

For an investor focused on longer term growth, leaving the profit to accrue keeps it invested and compounding monthly. The right election depends on the investor’s objectives, structure and tax circumstances.

12 Distributions a year

8%+ Historical annualized distribution rate

Where the income fits

The first article in this series asked whether a private credit allocation introduces a genuinely different return driver. Garrington’s historical correlation to public equities, traditional fixed income and broader direct lending benchmarks has been close to zero, because repayment is tied to the operating activity of private businesses.

This article takes the practical side of the same question. The income is produced by a short duration, senior secured, asset-backed loan portfolio. The distribution is variable and the strategy retains credit risk. What an investor can examine is the source of the income, the assets supporting it, and the process by which capital returns and goes back to work.

Yield tells an investor how much a strategy has produced. Following the cash explains how it was produced, and what has to keep working for it to be produced again.

In the next piece in this series, we look at the return path itself: what the line has looked like month to month, and what reaches an investor’s return when a loan does not perform as expected.

If you’d like to discuss, please feel free to contact us:

investors@garringtonprivatecredit.com