Private debt funds have emerged since the global financial crisis as a major force in the market and are poised for further growth as banks again struggle with stretched repayments and interest moratoriums amid COVID-19 disruption, opening up opportunities for private debt managers to take the keys from distressed borrowers and turn businesses around.
Going where banks are reluctant to tread, private debt funds have bloomed over the past decade, now holding well over three times the assets under management (AUM) that they had in 2008 when the global financial crisis changed the lending landscape forever. By the end of 2018, total global private credit AUM had grown to US$767.5 billion.
With substantial capital waiting to be put to work, private debt funds are able to provide financing for new deals and help provide liquidity to businesses that are experiencing short-term dislocations as a result of COVID-19 disruption. Further, firms with the largest direct lending funds also have extensive distressed debt and special situations capabilities. As distressed assets build amid the COVID-19 crisis, they will likely seek out opportunities to provide bridge financing with an attractive risk-return profile.
Why private debt is well placed to leverage new opportunities
By design, banks will always lend at the lowest risk profile; they will not operate beyond the spectrum of long-term debt and a bulk of their money will always be invested on the treasury side and in the listed bond markets. Even when extending funding to corporates, the risk profile cannot be stretched beyond a point since the money banks raise for lending comes from depositors who have the lowest risk appetite as well as a guaranteed right to withdraw their money at any time.
Meanwhile, private debt money is sourced from long-term funds, i.e. patient capital, and represents commitment by a seasoned investor who understands the risk-return framework and is willing to take higher risk in expectation of higher returns. These factors, taken together with an inclination among private debt fund board members towards adopting new and emerging technologies, explain why private debt firms can afford to be much more agile and responsive to borrower needs than banks.
With lower lending lead times becoming increasingly important in a COVID-19 context, when the borrower’s ability to access funds can mark a make-or-break moment in its existence, agile private debt players are well positioned to provide those much-needed lifelines, delivering mutual benefits.
And because of their innate ability to spot an opportunity, private debt funds will likely be nimble in investing in areas such as the pharmaceutical space with focus on generic drugs and vaccine research, or the work-from-home industry with emphasis on special equipment, services or software catering for the rising population of home workers and employers – all areas that have gained currency since the COVID-19 outbreak.
Why private debt is set to thrive in a post-COVID world
The velocity of deal-making in the private debt market may in fact increase further in the virtual “new normal”. In the private debt space, fund managers see at least a deal a week, if not more. A virtual world will likely suit the private debt decision-maker since less time is spent on physical travel and face-to-face meetings. This can only spell good news for the private capital space where decision-makers also typically use a lot of informal channels to arrive at the right conclusions faster and collaborate with other funds to take full advantage of an opportunity.
In terms of the future growth of the private debt space, market predictions are very positive. Particularly after the COVID-19 outbreak, in light of the interest moratoriums brought in by central banks in many countries to protect borrowers and keep corporate bankruptcy to a minimum, banks will inevitably find themselves capital constrained, opening doors for private debt firms to step in.
Indeed, after the 2008 financial crisis, many stringent regulations were imposed on banking capital, such as stricter capital adequacy ratios that were so far largely being compensated for by the banks ploughing back their own profits. However, this approach may no longer be an option as banks find their profitability impacted as their corporate borrowers feel the economic effects of COVID-19 and, in turn, are constrained in their repayment abilities.
Private debt: a safe bet?
In the end, the numbers speak for themselves. As of April 2020, there were 457 private debt funds seeking combined funds of US$201 billion, the highest ever recorded, according to data provided by Preqin in its Q1 2020 update.
Looking ahead, private credit could become the centre of attention as banks back away from the buyout market, leaving a gaping opportunity in their wake. Powered by their willingness and agility to embrace new technologies and take advantage of novel opportunities in emerging sectors, it is easy to see a bright future for the private debt market in an otherwise uncertain and volatile landscape.
