2018 in review: The dash for deployment

With so much capital raised in 2017, deploying it wisely and avoiding bad terms has become a major focus for managers in the past year.

A year ago, one of the biggest concerns about the private debt industry was whether it would be able to deploy the enormous sums of capital that had been raised.

Fortunately, the signs so far suggest managers have been able to originate enough deals to deploy the capital they have raised. Deloitte’s latest Alternative Lender Deal Tracker, which provides a breakdown of European mid-market deals over the past five years, has shown continued strong growth in deal volumes through 2018.

François Lacoste, managing partner at IdInvest Partners, says LPs are still concerned about deployment, but do not see it as a major barrier to investing in the asset class.

“LPs were frightened about deployment, they need to know you’re being selective,” he explained. “The size of asset manager is also an issue as you need to justify any growth in your fund and will face questions about deployment.”

Perhaps the most notable development in the deal space, as alluded to in our fundraising review yesterday, is that private debt managers are able to underwrite increasingly large sums and this has led to some being present on upper mid-market deals that were once solely the preserve of the major banks.

Klaus Petersen, partner at Apera Capital, said: “It’s not just regulation squeezing out the banks but also market participants who are increasingly able to underwrite big deals. Banks can’t underwrite loans like this anymore and are reliant on syndication.”

Market participants acknowledge that private credit is continuing to benefit from oppressive regulatory regimes imposed on banks in the wake of the financial crisis in 2008. However, they believe the market dynamic has now changed and that fund managers are now able to offer a genuinely competitive product.

The falling cost of capital, which has led to a growing number of firms raising senior debt funds, coupled with the ability to act quickly and with certainty in auction processes, means that private debt funds can get closer to banks in price and outcompete them in service.

This bodes well for the long-term future of the asset class and shows it is not purely reliant on the banking industry doing badly but can offer a competitive and attractive product in its own right.

The industry is also likely to see continued strong deal flow from the private equity sector, according to Jens Ernberg and Thomas Hall, co-heads of private credit at Capital Dynamics.

“Record levels of private equity dry powder, estimated at over $1 trillion globally, are expected be deployed in the next five years, driving demand for private credit,” they said.

However, being too reliant on private equity for deal flow could be detrimental to terms and conditions, according to Stuart Fiertz, co-founder of Cheyne Capital.

“In 2018 we’ve seen some of the most egregious EBITDA adjustments, intended to fool investors and give false comfort. But the loss of covenants and the loss of subordination will lead to lower recovery rates than many investors expect,” he warned.

“There is concern that so much direct lending has been focused on sponsor-led deals. Wider real economy borrowers are not yet used to non-bank lenders and we’re working to educate them.”

The non-sponsored segment has continued to grow in 2018, according to research by the Alternative Credit Council, but sponsor-led deal activity still provides the majority of deals. While private equity seems to provide a good opportunity for further deals in the coming years, lenders will need to pay close attention to term sheets to ensure they are not taking on more risk than they bargained for.