To achieve a consensus on a historical narrative is an aspiration seldom achieved. But there is agreement in the industry that the development of private debt as a fully-fledged asset class has come as a result of the constraints banks face in lending to the mid-market. Following the carnage of the global financial crisis, lending restrictions imposed on banks in the form of Basel III and the Volcker rule have accelerated the growth of private debt funds as banks continue to deleverage.
Last year was a bumper one on the fundraising front for private debt funds. Across 139 funds tracked by PDI research, €103 billion was raised, comfortably surpassing the 2014 figures. The latest PDI 30 report finds the top funds raising a combined $462 billion over the last five years. The asset class is evidently in the ascendancy as investors continue to look more favourably on debt.
But while the alternative lending funds may be growing in strength, it is premature to suggest that they are replacing the banks as the dominant source of financing in the mid-market. ‘Complementing’ rather than ‘competing’ is the word used by many in the industry – and this is perhaps no surprise as a number of funds have been spun out by banks, co-invest with banks or operate strategies focused entirely on acquiring underperforming assets from banks. That is also not to forget that the CVs of many managers are decorated with stints at the world’s leading financial institutions.
Cooperation may be the mantra on the fund side, but it’s perhaps a different story for the banks. A recent report from advisory firm AlixPartners found that banks increased their share of the mid-market senior lending space in the first half of 2016 at the expense of funds. For Jacco Brouwer, head of debt advisory at the firm and an author of the report, a likely explanation is that borrowers are seeking more conservative terms that fit with the banks’ lending restrictions. Amid an uncertain macro environment, companies may be thinking twice about more expensive credit or adding another turn of the screw on leverage.
Another reason for the shift is that banks may be responding to the threat of private debt funds by attempting to offer more flexible terms, speeding up the process or providing more covenant headroom – the very factors that make private debt funds attractive to borrowers.
Whether this is a long-term trend is perhaps too soon to tell. Brouwer cautions against extrapolating too many conclusions from six months of data, especially within a uniquely turbulent year that began with a slowdown in China, followed by the Brexit vote and even possibly being rounded off with the election of reality television star Donald Trump.
The factors that powered the rise of private debt are still in place: regulations that tighten lending continue to exist and borrowers will continue to look at more flexible options for their debt that will go beyond the capabilities of the banks. Across Europe, countries are opening up space for alternative investment funds to originate loans with the encouragement of the European Commission. And this year alone, debt funds are increasingly encroaching on the space previously considered the sole domain of the banks by underwriting larger tickets, whether in a club structure or alone (in the case of GSO).
It’s unclear whether banks are responding to the threat of debt funds or whether borrowers are content with more conservative terms. But within the context of this seemingly unpredictable year, it’s perhaps wise for now to see this as a blip, rather than a long-term trend in favour of the banks.