Citywealth: Private debt – A global overview

With the development of new products, like Blackstone’s institutional private credit platform for individual investors, we look at the private debt market, its benefits and the impact of regulation, considering the opportunities available for private client investors and investment managers as private debt remains in demand.

The private debt market: latest updates

Gautier Despret, Head of Debt at IQ-EQ, based in Luxembourg, says: “Private debt is already on the rise worldwide, having grown tenfold in the past decade, and has become part of a complementary financing model for banks and investors across the world. Money is beginning to flow into the asset class, with new investors keen to be involved, across both institutional and retail investors. Preqin data indicates that its growth will be rapid, accelerating to a CAGR of 17.4% between 2022 and 2026, and will become the second largest alternative asset class in the world. This expansive growth is only likely to continue in the current market, as it is a good inflation hedge, and offers the potential of strong returns for investors. According to Preqin, 91% of private debt investors intend to maintain or increase allocations to private debt over the long term.

Europe is already well positioned to be the global epicentre of the debt revolution, having consistently demonstrated double-digit growth, and Luxembourg is playing an influential role. Luxembourg is the second largest market for funds and has the structures in place to deal with the complexities that private debt funds are bound to face.”

Evgeny van der Geest, Managing Director at Aeon Investments, a credit-focused investment manager based in London, comments: “Market volatility and increased regulation are testing traditional lenders’ credit appetite, with sponsors and borrowers looking for longer-term partnerships to enable them to steer their businesses through the cycle and capitalise on sporadic growth opportunities.

In the current environment, borrowers require additional flexibility and speed of execution. Although not insulated from economic and fiscal challenges, the private credit community is better placed to accommodate such requests.

While the activity in syndicated LBO (leveraged buyout) financing has temporarily declined, demand for whole loan financing in the real assets space has increased as traditional lenders have curbed their risk appetite for underwriting capacity. Direct lending remains a major strategy within private debt, but specialised fund finance (e.g., NAV lending) and special situations lending have seen significant growth since the COVID19 pandemic.”

Michel Degosciu, Co-founder and CEO at LPX AG, a listed private debt research house and index provider, adds: “Considering the latest trends that we have seen in the US, and now also in Europe, we noticed senior debt and subordinated debts being packaged into one loan instrument. In private debt we usually see floating interest rates, which reduce the risk that a debt investor typically takes on when investing in traditional bonds with a duration. The past few years have shown what impact rising interest rates can have on a portfolio of government bonds; for example, the Bloomberg Global Treasuries Index returned -16.75% over the last 2 years. In comparison, the DLX Direct Lending Index (which tracks listed private debt companies) returned -0.35% over the same period.”

Benefits and regulation impacting private debt

Talking about the benefits associated to private debt, Michel Degosciu summarises: “Private debt provides access to medium-sized companies that are often market leaders in a niche in addition to stable returns with almost no duration risk.”

“Similar to traditional lenders, private capital providers can offer a full suite of products to their customers, ranging from enterprise growth financing to senior asset-backed debt”, says Evgeny van der Geest. “They are also typically less constrained by external regulatory frameworks and internal requirements to cross-sell and can employ a more consultative approach to underwriting, often resulting in faster and more predictable outcomes for the borrower.

Over the last six months, acquisition activity across numerous sectors was supported by private whole loan finance providers rather than combinations of senior and mezzanine debt offered by separate institutions, allowing borrowers to fulfil their capital requirements with a single lender rather than having to manage complexities associated with a combination of traditional bank products.”

Evgeny also adds: “Regulatory capital considerations have increasingly hampered traditional lenders’ ability to deploy capital without explicit requirements to syndicate. Sharp increases in liability costs and volatility in the public credit markets outpaced the windfall that deposit taking-institutions enjoyed from the recent interest rate rises.

Depending on the nature of the private institution, certain lending and asset management activities are in the scope of regulatory control and reporting. For instance, nearly all state-supported lending activities during the COVID pandemic were subject to explicit licencing requirements leading to reduced secondary market liquidity of such (private) debt instruments.

Separately, the growth of private credit markets is coupled with a significant inflow of institutional capital instigating requirements for private ratings of the credit instruments as well as standardised asset reporting. These developments have led to private credit becoming a more transparent, liquid and accessible investment class.”

What are the opportunities available for private client investors and investment managers? Our experts think that…

… market conditions, the threat of worse to come, and constraints on banks’ lending sheets have all led to a landscape in need of a revolution – with a timely option that is going to increase investors’ returns, as well as being the financer of the real economy. Private debt is on the rise across Europe and is well placed to fill this void. But they must take note of the unique nature of private debt as an asset class, as well as new AIFMD regulations. The asset class is a particular complex one, and one where a strong expertise is very highly needed. Private debt has a huge opportunity to lead a revolution to supercharging investors’ returns, but only if it falls into the right hands. Gautier Despret, IQ-EQ

… structured credit instruments underpinned by high-quality collateral continue to present investors with a good opportunity to access non-commoditised cashflow-producing assets. These instruments offer additional flexibility to investors allowing them to pick a position within a capital structure based on their bespoke risk-return and duration considerations; sophisticated credit providers employ standardised rating and risk reporting frameworks to allow investors to benchmark the instruments against public proxies; since 2010 investors have been steadily increasing their footprint in the traditional credit markets often working alongside or competing with bank lenders; unlike traditional lenders, private lenders can provide investors with unique access to specialised asset classes such as diversified portfolios of small balance sheet real estate, small and medium-sized enterprise credit, and residential mortgages. Evgeny van der Geest, Aeon Investments

… listed companies providing private debt are highly regulated and have to fulfil various requirements by the stock exchange. They are also very transparent due to the requirement to publish their investments. Through direct lending indices, such as DLX, investors can gain access to these without any minimum investment or lock-up period; second option is to invest via structures that are not publicly available, typically closed-end funds. The regulation depends on where the fund is located and can vary substantially. An investor has to make an in-depth due diligence before investing in such instruments; third option is via platforms that match investors and companies seeking for debt capital. These are relatively less regulated. Again, it depends on where the platform is located and regulation can vary significantly. Michel Degosciu, LPX AG

Citywealth

Private debt: A global overview

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