Private credit grappling with margin pressure

By Admin

14 Jul, 2025

By Mahesh Nayak

India's private credit market, long heralded as a high-yield haven for investors, is now contending with margin pressures that reflect deeper shifts in the ecosystem. Once known for delivering attractive internal rates of return (IRR) in the 15–16% range, the market has seen yields compress by nearly 100 basis points. Today, many performing credit funds are operating within a tighter 13–14% return band.

Market Maturity Meets Competitive Surge

This compression isn't simply a result of cyclical forces. As private credit becomes more mainstream, the space has seen an influx of diverse players from institutional heavyweights to wealth management platforms and mutual fund-led AIFs (Alternative Investment Funds). The increased competition has driven aggressive underwriting practices and diluted covenant discipline.

“It's a strategic recalibration,” said Priyam Kedia, Senior Fund Manager at Vivriti Asset Management. “Softer consumption trends and export volatility have reshaped our thesis. We’ve shifted from a cash-flow-only model to one that emphasizes security for downside protection. Our third-generation funds now target an IRR of 15.5%, down from 16–16.5% earlier.”

Back to Basics: Risk Protection Over Yield Chasing

While investor appetite remains strong, fund managers are returning to core principles prioritizing collateral-backed security and reducing overreliance on free cash flows. A senior fund manager from a domestic alternative fund noted, “The shift is structural. Faster closures, lighter due diligence, and compromised covenants are impacting long-term portfolio resilience.”

One of the major disruptors reshaping the economics of deal-making is the entry of mutual fund platforms into the AIF space. Leveraging brand equity and extensive distribution networks, mutual funds like HDFC, ICICI Prudential, Axis, Nippon, and Kotak Mahindra are creating ripples. However, their presence has altered the fee-sharing model drastically.

Distributors now demand 60–65 basis points from the 150 bps fee pool, leaving fund managers with limited room for rigorous diligence and governance. The emphasis has tilted toward a product-push model, often compromising credit quality in favor of volume and velocity.

Velocity Over Vigilance?

The proliferation of funds targeting similar mid-market borrowers has crowded the pipeline, with many deals closing within 10–15 days. Thyagesh Baba, Director at Spark Capital Advisors, cautioned, “Speed comes at the cost of underwriting depth. Institutional platforms with seasoned teams are differentiating themselves from wealth-led platforms that prioritize rapid scale.”

Even with abundant liquidity in the market, much of it is focused on refinancing existing loans rather than funding new growth. Still, investor confidence hasn’t waned. Family offices and HNIs are allocating 7–9% of their portfolios to private credit up significantly from the 2–4% allocation just a few years ago.

A Divergence in Strategy

This enthusiasm is partly driven by regulatory changes such as the removal of indexation benefits in mutual funds. “HNIs are chasing yields,” said Nilesh Dhedhi, Managing Director & CEO of Avendus Finance. “Many are now investing in funds with 18–22% return targets after being satisfied with lower-yielding papers.”

Yet, this aggressive appetite has given rise to a risk-return mismatch. While some funds delve into stressed or asset-light deals to boost IRRs, others remain disciplined, focusing on companies with EBITDA above ₹75–100 crore and requiring 3–4x collateral coverage. This divergence is expected to trigger a market shakeout, where only funds with robust monitoring and resolution capabilities will survive.

The Road Ahead

Despite the pressures, the outlook remains optimistic. As Baba from Spark Capital Advisors emphasized, “The private credit market could grow 5 to 10 times over the next decade. But this will only be possible if we reinforce underwriting discipline, promote investor education, and reform distributor incentives.”

In summary, India’s private credit sector is at a crossroads. While the growth potential is undeniable, it comes with a clear caveat only those who adapt to the evolving landscape with a long-term, disciplined approach will thrive. The era of easy alpha is over; the future belongs to those who can balance yield with prudence.