Private Debt – Outlook For 2021

Is the old new again?

Providing loans to companies has historically been one of the main components of commercial banking activity and goes back hundreds of years. Today, private debt comes in many forms, but most commonly involves non-bank institutions making loans to private companies based on the cashflows generated by the respective business, or for the acquisition of a hard asset (e.g., real estate) or acquiring existing loans on the secondary market.   

Since the global financial crisis, private debt has received increased attention and growth for a variety of reasons, not the least of which include an ongoing low interest rate environment, elevated equity valuations and investors seeking diversification as well as yield enhancement to traditional listed fixed income.

The chart below reflects some of the main characteristics of typical private loans.

(Click on image to enlarge)

Characteristics

Companies always need capital to grow

The chart below illustrates the various sources of capital available (or not) to companies of a variety of sizes. Small and lower middle market companies (as measured by EBITDA) have the least access to capital from more traditional sources, such as banks and the syndicated loan market. Therefore, such companies are among the primary users of loans from private providers. The universe of potential borrowers is broad, particularly in the U.S. and Europe, when considering that there are 25,000-50,000 companies in those regions in the lower middle market. As with any private debt investment, due diligence on creditworthiness of borrowers, and expertise in structuring the loan and relevant covenants are key elements to a successful investment.

(Click on image to enlarge)

Appeal of private debt by size

Source: Campbell Lutyens November 2019

Banks pulling back from lending created opportunity in direct lending

Structural changes in the financial services industry since the global financial crisis have generated demand for nonbank loans. Although banks still dominate corporate lending, they have pulled back from the lower end of the middle market, reducing their exposure to these loans in response to industry consolidation and increased regulation.

The chart below reflects that trend.

(Click on image to enlarge)

Trends in corporate lending by banks

1Source: Federal Deposit Corporation (FDIC), "Statistics at a Glance: Latest Industry Trends."

Source: S&P's LCD Q3 Leverage Lending Review.

Asset managers in the U.S. are regulated by the Securities and Exchange Commission (the SEC)—therefore, not subject to the same restrictions as banks. This flexibility is an added benefit to sponsored lending, especially for more complex transactions like buy-and-build, where there are a number of add-on acquisition financings as part of the strategy. In addition, banks tend to provide larger syndicated loans to big corporations and fewer loans to smaller to mid-market companies. Because of the supply/demand imbalance, middle-market companies are willing to pay higher interest rates for access to capital, attracting non-bank lenders to fill the gap. This trend has enabled middle-market companies needing financing to obtain it. And private lenders are able to offer higher investment yields to investors.

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Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.

Investing involves risk and ...

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