Private debt has become a hot topic for fund managers desperate to create a fee-rich asset class at a time when their traditional businesses are struggling. But even industry insiders warn the private debt boom is turning into a frenzy.
Once a niche in the global asset management industry, assets invested in private debt – mostly non-bank loans to unlisted companies – hit a record $ 812 billion in 2019, putting the market on on track to cross the $ 1 billion mark in the next year.
The number of asset managers operating in the field also hit a new record last year, totaling 1,764, more than double the amount five years earlier, according to consulting firm Preqin.
The main managers competing for assets have historically been US private equity giants with credit arms, such as KKR and Blackstone. But more traditional fund groups, including M&G, Schroders, Amundi and Standard Life Aberdeen, have made forays into the market in recent years, eager to cash in on investor appetites.
Private debt is spreading as investors seek higher yields. Its growth was spurred by banks that exited the market when they streamlined their loan portfolios to comply with stricter capital rules.
“Sovereign wealth funds and large public pension plans were among the first to adopt them, but more and more the rest of the institutional investor world followed suit,” says Ji-Eun Kim, head of management solutions. private assets at Schroders. “Private debt. . . the improved cash yields are particularly attractive in a low yield environment. “
However, a growing number of personalities are expressing their fears that the market will appear sparkling, because too much capital drives too few transactions.
“It would be crazy to start a private debt business right now,” says a former senior private debt executive. Another senior private equity fund manager believes the asset class is in bubble territory. “We see the same movie happen every time. When too much money goes into one place, the result isn’t great.
Vulnerabilities are already exposed. In early February, Hadrian’s Wall Secured Investments, a listed fund that has loaned money to UK small and medium-sized businesses, announced it was shutting down its operations after warning of “material” losses on investments in two biomass companies.
Preqin data shows that over the past four years, 327 direct lending funds, the most common type of private lending strategy, have been raised, with around $ 207 billion paid into the strategies.
At the same time, the dry powder – the amount raised for direct loans but not invested – hit a record $ 112 billion.
The dry powder for all private credit, including strategies such as distressed debt and mezzanine debt in addition to direct lending, stands at $ 261 billion, down slightly from the previous year but still represents the second highest level on record.
The recent capital raising frenzy, combined with fierce competition among lenders, is hurting yields, and lending standards are suffering.
Jaime Prieto, managing partner at Kartesia, an asset manager that lends to SMEs, says some managers are giving in to pressure by agreeing to weaker loan terms and more flexible terms.
A former senior executive agrees, adding: “The huge amount of free float means that there is inevitable deterioration in credit quality. ”
He says go up leverage the pool of private assets is proof that the problems are piling up the same way they did as the subprime mortgage market crisis approached.
Mariano Belinky, managing director of Santander Asset Management, which set up a private debt unit last year, says more issues are looming.
He highlights the recent wave of seed fund launches as a matter of concern. Last year, a private debt fund managed by BlueBay Asset Management raised € 6 billion, while a vehicle from Alcentra, a subsidiary of BNY Mellon, closed at € 5.5 billion, or nearly twice its minimum target.
“How to deploy this capital on a large scale? ” he asks. “As the asset class continues to heat up, many of these managers will have a harder time finding good deals. “
Other industry executives are warning that the currently visible cracks will get much worse when the market cycle turns.
Nicholas Brooks, head of investment research at Intermediate Capital Group, the £ 42.6 billion specialist credit manager, says rising markets over the past decade have masked problems lurking beneath the surface . “There are probably a number of new players who are recklessly loaning, but we won’t find out until the next downturn.”
There are also concerns that some fund groups have jumped on the private debt bandwagon without the skills to fully understand the risks of the loans they make.
“As managers raise larger funds, the question becomes whether they can make large enough loans and do they have teams of experienced people to deal with issues when issues arise,” says Paul Shea, co-founder of specialist Beechbrook SME loan manager.
Mr Belinky said Santander AM’s private debt unit, which enjoys access to its parent bank’s origination pipeline, has been approached by groups who are struggling to find deals on their own. .
“The managers came over and said, ‘Hey, we’ll buy 50% of everything you produce.’ This gives you an idea of how managers have limited access to great deals.
But Ken Kencel, chief executive of Churchill Asset Management, a $ 21.5 billion private debt firm, which reviewed 800 potential deals last year, takes a different view, saying opportunities abound.
He says credit quality holds up, especially in the upper end of the market where fewer managers compete. Competition has long been fierce among managers seeking loans for small and medium-sized businesses.
Kencel says groups capable of issuing larger checks to businesses are still in the minority and will thrive in the years to come.
But writing big checks is also risky, making it even more important for fund managers to have large teams of professionals to oversee the loans they have made.
Established private debt managers who benefit from the income streams of existing funds can afford to finance this. But newcomers can take years to realize a profit given the high costs of obtaining private loans and the fact that many groups charge management fees based on the amount of money they have invested instead. that lifted.
Many believe the market is ripe for a wave of consolidation that will see smaller, less specialized groups ousted or merged with competitors. Investors are increasingly turning to more established managers with larger funds; According to Preqin, the 10 largest funds that closed last year accounted for 36% of new capital raised.
Mr. Belinky says some managers are already admitting defeat. When her company was recruiting for a new private debt team last year, it received applications from professionals whose former employer was forced to shut down their private debt funds because they couldn’t find enough money. companies to lend to. “When we asked them, they said they had commitments from investors and were ready to go, but they just couldn’t find enough assets to put the capital to work.” , he said.
In January, Swedish private equity firm EQT said it was considering shedding its € 3.9 billion credit arm to focus on its core business. M&A activity is already underway among entities specializing in direct lending in the United States, known as Business Development Companies or BDCs. Crescent Capital acquired BDC from Alcentra last year, bringing its investment portfolio to $ 923 million in assets.
“In a more difficult credit environment, some of the smaller stores will find it difficult to manage their portfolios and will have the resources to deal with their portfolio restructuring,” said Mr. Kencel. “Rather than spending a lot of time fixing these issues, some will likely choose to sell. “