Bubble talk

The ‘b’ word has been used in relation to private equity. Should its close relative private debt be worried?

“Flood of cash triggers buyout bubble fears” ran the headline in the Financial Times this week, as the private equity asset class, not for the first time in its history, found itself under investigation for evidence of over-exuberant behaviour amid strong investor appetite.

But is there substance behind the implication of worrying times ahead? There does seem to be something of a mismatch between the wall of capital being raised and the opportunity to deploy that capital. Few would dispute that, consequently, private equity is highly competitive (although when has it ever been uncompetitive?).

However, it’s not just hot air supporting this so-called ‘bubble’: there are solid building blocks. Low inflation and interest rates continue to assist a benign economic outlook. Indeed, earlier this week, at the gathering of the great and good in Davos, the International Monetary Fund raised its forecast for global growth to 3.9 percent for 2018 and 2019, up 0.2 percent on its October forecast.

With such solid economic underpinnings, this hardly looks like a speculative phenomenon on the scale of the Dutch tulip crash in the 1600s or – to borrow a rather more recent example – the US subprime crisis.

So maybe private equity shouldn’t be too worried. And, if that’s the case, maybe private debt shouldn’t be too concerned either. In a series of shortly-to-be-published features on sponsor finance, we reveal that the symbiotic relationship between private equity and private debt is as strong as ever. Despite the much-touted advance of sponsorless deals, around 80 percent of private debt deals in Europe are still backed by a private equity firm – a figure which has remained very consistent over the years.

On the back of the private equity surge, private debt has advanced in lockstep and is now capable of raising close to $200 billion per year globally. In light of this, with private equity attracting excitable headlines, shouldn’t private debt also be forced to confront its own possibility of a bubble?

In a court of law, the cases for and against could be argued persuasively. Default rates remain resolutely low on both sides of the Atlantic; but historic data show they can be notoriously fickle, with sudden upward spikes interrupting long periods of calm. Average leverage in deals is higher than it has been for many years, but large equity cushions are giving lenders comfort that they will not be the ones facing wipe-out in the event of stress. Covenants have undoubtedly become “lighter” but some welcome the flexibility allowed by this, arguing that some highly covenanted companies are plunged into default more rapidly than they need to be.

The mood in the market is certainly not one of panic or even particularly unsettled. Market players are quick to acknowledge the pressure points and the need to be aware of the possibility that things could go wrong. Complacency is arguably a real enemy, bubble talk a mere distraction.