Private Credit

Introduction

Private credit has emerged as one of the fastest-growing segments of alternative investments globally. What was once the exclusive domain of banks — lending money to businesses and property owners — is now increasingly the province of private funds, institutions, and individual investors.

For Canadian accredited investors, private credit often means Mortgage Investment Corporations (MICs). But MICs are just one slice of a much larger market that includes direct lending, mezzanine financing, distressed debt, and specialty finance.

This guide explores the private credit landscape — what it is, how it generates returns, the risks involved, and how Canadian investors can access this asset class.

The Global Context

The global private credit market has grown from approximately $300 billion in 2010 to over $1.5 trillion in 2024. This growth reflects a fundamental shift: traditional banks have retreated from many lending activities due to regulatory constraints (Basel III capital requirements), creating opportunities for non-bank lenders.

Major players include Ares Capital, Apollo, Blackstone Credit, KKR, and Golub Capital — names institutional investors know well but that may be unfamiliar to retail investors.

Why the shift matters for investors:

Higher yields: Private credit typically offers 200-500 basis points more than comparable public bonds, compensating for illiquidity and credit risk.
Floating rate structures: Most private credit is floating rate (tied to SOFR or bank prime), providing natural inflation protection that fixed-rate bonds lack.
Lower volatility: Because private credit isn't marked to market daily, reported returns are smoother — though this masks rather than eliminates underlying risk.

Why banks left the space:

Post-2008 regulations require banks to hold more capital against loans, making many lending activities less profitable. Private lenders face no such constraints. This regulatory arbitrage is a feature, not a bug — but it also means private credit operates with less systemic oversight.

What Is Private Credit?

Private credit encompasses any non-bank lending where the debt isn't traded on public markets. The unifying characteristic: you're lending money to a borrower (directly or through a fund) in exchange for interest payments and eventual return of principal.

Unlike bonds, which trade on exchanges and have transparent pricing, private credit is:

Negotiated: Terms are custom, not standardized
Illiquid: No secondary market (or very limited)
Relationship-driven: Lenders often have ongoing dialogue with borrowers
Secured (usually): Collateral provides downside protection

Major Categories

Direct Lending (Senior Secured) Loans to middle-market companies, typically secured by company assets with first-lien priority. This is the largest segment of private credit and the closest analog to what banks used to do.

Mezzanine Debt Subordinated loans (junior to senior debt) with higher interest rates reflecting higher risk. Often includes equity "kickers" like warrants that provide upside if the company performs well.

Distressed Debt Buying the debt of troubled companies at a discount, either to profit from recovery or to gain control through restructuring.

Real Estate Debt Loans secured by property — exactly what Canadian MICs do, though institutional real estate debt funds operate at larger scale.

Specialty Finance Asset-backed lending against specific collateral: equipment leases, receivables, royalties, litigation funding, etc.

Private Credit in Canada: The MIC Landscape

For most Canadian accredited investors, private credit exposure comes through Mortgage Investment Corporations (MICs).

What MICs Are

A MIC is a Canadian tax structure designed specifically for pooled mortgage lending. Under the Income Tax Act, MICs must:

Have at least 20 investors
Invest primarily in mortgages or cash
Distribute all taxable income to shareholders
Not be controlled by non-residents

In exchange, MICs are tax-transparent — like REITs, they don't pay corporate tax if they distribute their income.

How MICs Generate Returns

MICs pool investor capital and lend it to borrowers as mortgages. The spread between what borrowers pay and what investors receive (after fees and expenses) is the investor return.

Example:

MIC lends at 10% average rate
Administrative costs: 1%
Management fee: 1.5%
Net to investors: ~7.5%

Returns are driven by:

Interest rates charged: Higher rates = higher returns, but higher risk borrowers
Leverage: Some MICs borrow to amplify returns (adds risk)
Default rates: Losses reduce returns
Fee structure: High fees erode investor returns

Types of MIC Lending

Residential mortgages — First or second mortgages on homes, often to borrowers who don't qualify for bank financing (self-employed, poor credit, non-standard properties).

Commercial mortgages — Loans on income-producing properties (apartments, retail, office, industrial).

Construction/development loans — Higher-risk loans for building projects, often short-term with higher rates.

Land loans — Loans secured by undeveloped land, the riskiest category.

What Went Wrong (Case Studies)

Canadian MIC investors have faced significant losses in recent years:

Fortress Real Developments (2018): Syndicated mortgage investments collapsed, leaving investors with massive losses. Regulatory response: tighter rules requiring syndicated mortgages to be sold through registered dealers.

Building & Development Mortgages (2020): A large MIC faced liquidity crisis during COVID, suspending redemptions and leaving investors trapped.

Bridging Finance (2021): Alleged fraud leading to receivership. Investors lost substantial portions of their capital.

These failures share common elements: concentration in higher-risk construction/development lending, related party transactions, inadequate disclosure, and liquidity mismatches between investor expectations and actual portfolio liquidity.

MIC Due Diligence Checklist

Portfolio Composition:

What percentage is first mortgages vs. second mortgages vs. construction/development?
What's the weighted-average loan-to-value (LTV)?
What's the geographic concentration?
What's the average mortgage size (concentration risk)?

Underwriting Standards:

What LTV limits are applied by loan type?
What debt service coverage ratios are required for commercial loans?
How are property appraisals obtained? By whom?
What's the historical default rate?

Liquidity:

What are redemption terms (notice period, frequency, caps)?
What's the historical redemption rate?
Has the MIC ever suspended or limited redemptions?
What's the cash position?

Governance:

Are there independent directors?
Are financial statements audited by a reputable firm?
What related party transactions exist?
What's the manager's track record and reputation?

2023 Regulatory Updates: New Schedule 2 disclosure requirements under NI 45-106 mandate enhanced information for "collective investment vehicles" including MICs — mortgage portfolio details, default rates, and related party transactions must now be disclosed in offering memorandums.

Beyond MICs: Broader Private Credit Access

Canadian accredited investors increasingly have access to institutional-quality private credit beyond MICs:

Direct Lending Funds

Funds that lend to middle-market companies (typically $10-500 million in revenue). These loans are usually:

Floating rate (SOFR + 500-700 bps)
Senior secured (first lien on company assets)
Covenant-protected (financial tests the borrower must maintain)

Returns typically target 8-12% net, primarily from income.

Canadian access: Some US managers accept Canadian accredited investors. Canadian platforms like Ninepoint and others offer private credit funds.

Real Estate Debt Funds

Similar to MICs but at institutional scale with more diversification and professional management:

Larger loan sizes ($10-100+ million)
Diversified across property types and geographies
Often including US and international exposure
Higher minimums but better risk controls

Business Development Companies (BDCs)

US-listed vehicles that lend to middle-market companies. Publicly traded (providing liquidity) but focused on private credit. Names like Ares Capital (ARCC), Owl Rock (ORCC), and Golub are examples.

Canadian considerations: BDCs are US securities with US tax implications. Dividends may be subject to US withholding tax. Currency exposure is also a factor.

Private Credit Risk Analysis

Credit Risk

The borrower may not repay. Unlike public bonds with credit ratings and research coverage, private credit requires reliance on the lender's underwriting. Key questions:

What's the borrower's ability to service debt (debt service coverage ratio)?
What's the collateral value relative to loan amount (LTV)?
What's the lender's track record in avoiding defaults?
What recovery rates has the lender achieved on defaulted loans?

Illiquidity Risk

Private credit is illiquid. MICs may offer quarterly redemptions but can suspend them in stress. LP structures may have multi-year lockups. If you need your capital, you may not be able to get it — or you'll take a significant discount.

Interest Rate Risk

Most private credit is floating rate, so income rises when rates rise. But higher rates can stress borrowers, increasing defaults. The 2022-2024 rate hike cycle is testing private credit portfolios that were underwritten at lower rates.

Valuation Risk

Private credit isn't marked to market daily. NAVs are based on manager estimates and periodic appraisals. A MIC reporting stable NAV while real estate markets decline may be deferring recognition of losses, not avoiding them.

Structural Risk

Leverage at the fund level: Some private credit funds borrow to enhance returns. This amplifies both gains and losses.

Liquidity mismatch: A fund offering quarterly redemptions but holding illiquid loans creates redemption queue risk — later redeemers may face worse outcomes.

Concentration: A MIC with 50% of assets in one project or borrower has concentrated risk regardless of label.

Manager Risk

In private credit, the manager is everything. They source deals, underwrite risk, structure terms, and work out problems. A skilled manager can earn 10%+ in a good environment and preserve capital in a bad one. A poor manager can lose significant capital in any environment.

Private Credit vs. Public Fixed Income

| Factor | Public Bonds | Private Credit | |--------|--------------|----------------| | Yield | Lower (spread compression) | Higher (illiquidity premium) | | Liquidity | Daily | Limited/None | | Transparency | High (ratings, pricing) | Low (manager-dependent) | | Interest Rate Type | Usually fixed | Usually floating | | Volatility | Mark-to-market | Smoothed (appraisal-based) | | Diversification | Easy via ETFs | Requires multiple managers/funds | | Minimums | Any amount | $25K-$250K+ | | Correlation to Equities | Moderate | Lower (but increases in crises) |

When Private Credit Makes Sense

You have a long time horizon (5+ years)
You don't need the capital for emergencies
You want income that adjusts with inflation/rates
You can evaluate manager quality or access advice to do so
You have sufficient portfolio size to diversify across managers

When It Doesn't

You might need the capital short-term
You're reaching for yield without understanding the risks
The only option available has concerning characteristics (concentrated, opaque, high fees)
You can't evaluate or don't trust the manager

Allocation Considerations

How much? Institutional investors typically allocate 5-15% of fixed income portfolios to private credit. For individual investors, 5-10% of total portfolio may be appropriate — but only if the allocation is diversified across managers and strategies.

Don't replace emergency funds. Private credit is not a savings account. The higher yield comes with lockups and risks.

Diversify the diversification. One MIC is not a private credit allocation — it's a single-manager concentrated bet. True diversification requires multiple managers, strategies, and vintages.

Consider fees carefully. A fund earning 10% gross but charging 2% management and 20% performance fee delivers much less net. Compare after-fee returns to alternatives.

Canadian Tax Considerations

MIC income is typically ordinary income (interest), taxed at your marginal rate. There's no dividend tax credit and no capital gains treatment on regular distributions.

Return of capital (ROC): Some MICs distribute ROC, which reduces your adjusted cost base and is tax-deferred until you sell. This isn't "tax-free" income — it's tax deferral.

RRSP/TFSA eligibility: Most MICs are qualified investments for registered accounts, which can be advantageous given the ordinary income treatment.

US private credit: Investments in US vehicles may trigger foreign reporting requirements, withholding taxes, and other complexities. Consult a cross-border tax advisor.

Key Takeaways

Private credit offers higher yields than public bonds — but the premium compensates for illiquidity, credit risk, and complexity. There's no free lunch.
MICs are Canadian private credit in its most accessible form, but they vary enormously in quality. Treat each one as a unique investment requiring full due diligence.
Recent failures (Fortress, Bridging, etc.) weren't random. They resulted from concentrated risk, inadequate disclosure, and misaligned incentives. Learn from these patterns.
Manager selection is paramount. In private credit, you're betting on the lender's skill in underwriting, structuring, and working out problems. A bad manager can lose money in a good market.
Floating rates are a feature, not just a benefit. They protect against inflation but can stress borrowers when rates rise sharply. Monitor portfolio credit quality as rates change.
New 2023 disclosure rules help but don't solve everything. Use the enhanced OM disclosure (Schedule 2) as a starting point, not a substitute for deeper analysis.

This guide is educational content only. It does not constitute investment advice or a recommendation of any specific security. Consult a registered advisor before making investment decisions.

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