A big talking point in private debt circles is the importance of being well prepared for the downturn when it comes. This is often couched in negative imagery – think of building shelters as protection from an approaching storm, and you get the idea.
Respondents to the recent Financing the Economy 2018 survey by law firm Dechert and the Alternative Credit Council reinforced the sense of challenges to come. They predicted significant growth in the distressed market, in part fuelled by the expectation that interest rates would rise and make it harder for some borrowers to meet existing loan commitments or to refinance.
The sheer length of the current benign credit cycle was also taken as a likely sign that the economy will enter a period of less certain growth than in the past. In other words, industry players have the nagging feeling that they have enjoyed too much of a good thing and there must, at some point, be a reckoning.
What perhaps has received less publicity is the chance for the private debt universe to expand further as and when conditions worsen. The survey says that both existing distressed managers, as well as others which may move into the space, could find opportunities to finance a larger population of borrowers.
As conditions worsen, banks will inevitably look to remove distressed debt from their loan books – offering private credit managers the chance to develop relationships with borrowers that have in the past been wholly reliant on bank financing. Given how long the benign cycle has lasted, it’s been a long time since funds have been in a position to grab significant market share in this way.
The hope will be that many of these borrowers, grateful for the opportunity to refinance debt and not wanting to give up equity, may end up embracing the flexibility and partnership offered by funds and thus become permanent converts. Despite current difficulties, many may be strong businesses burdened with loans made on the wrong terms.
This is one reason why the private debt asset class can take comfort from the survey. There are others, including that dry powder is currently below the 18-year average at just 37 percent of global private credit assets under management. When combined with the deal surge identified here by Deloitte’s Alternative Lender Deal Tracker, the evidence suggests the asset class is far from falling foul of the old “too much money chasing too few deals” adage.
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