Founder & CEO, Percent
Managing director and co-founder, Fund Finance Partners
Executive director, HPS Investment Partners
How do you see the private debt markets developing in 2022?
Nelson Chu: Private debt remains one of the top markets because it powers so much of the economy – it is the ‘go to’ source of funding for so much of small business and consumer lending. Given the overall negative macro sentiment and a rising rate environment, the private debt market, in particular, will be a bellwether for the overall health of the real economy.
Richard Wheelahan: Through the first half of 2022, and I would anticipate the latter as well, the specialisation of the asset side of private debt has accelerated. Performing corporate leveraged finance strategies still dominate the menu, but alternative strategies (those not tied to cashflow multiples) are increasingly blooming. Allocators or investors in private debt seem to be enthusiastically meeting those opportunities, and I’m encouraged by the pace at which providers of leverage to private debt funds are evolving to accommodate those strategies.
Rachel Zagajewski: Volatility in the public markets has continued to push better and bigger companies to consider private debt as an option when seeking access to capital. Ongoing market volatility reduces banks’ willingness to provide committed financing and creates uncertainty around the availability and terms of traditional capital. The certainty and speed with which companies can execute a transaction in the private debt markets is likely to continue to expand the number and quality of [companies/issuers] in the space.
Are there any significant trends? Any sectors or strategies that are outperforming expectations?
NC: We are seeing substantial funding activity despite macro headlines and headwinds. Debt needs to be refinanced continuously, regardless of whether market sentiment is positive or negative, so issuers who need to refinance will have to adapt to the rising funding costs. As fixed rate deals are replaced with floating rates, the arbitrage between public and private debt pricing is narrowing for the first time since the financial crisis. Still, we think the market will remain resilient despite volatility.
One emerging trend – providing private debt options to public debt issuers – is likely here to stay as broader markets remain volatile. Patient, long-term debt providers who are nimble and can play up and down cap structures will have a variety of opportunities while public debt markets struggle to get over the finish line. Investor diversification has always been a key theme of any defensive issuer, but market diversification is proving equally beneficial.
RW: NAV lending (ie, lending to private equity, real estate, venture or other funds on the basis of net asset value, rather than uncalled capital commitments) certainly became mainstream during the pandemic, but it’s still growing post-pandemic. Certain esoteric, or sub-scale, structured finance strategies are also increasingly attractive to private credit fund sponsors, institutional investors and debt capital sources.
RZ: Several trends have been observed over the last few years in the private credit market. The increased competition among debt investors has been well-covered in the industry press, with managers raising record-levels of capital and plenty of new entrants to the space.
However, the opportunity set has not been static over the same time period. The size of the overall private credit market now rivals the syndicated market and has grown 5-6x since the global financial crisis in 2007/08. The upper end of the direct lending market is a particularly interesting opportunity for scaled capital given the relative lack of competition among managers.
Are there any sectors or strategies that are cause for concern?
NC: Private debt has experienced a big boom after the financial crisis from these non-bank lenders who have so far been heavily capitalised, and one could argue subsidised, by venture capital. The historically low-rate environment is over for the foreseeable future, and as rates rise, there will be significant pressure on these tech-enabled lenders to deliver on what they promised. Can they actually use technology to do better underwriting and make it a more profitable endeavour compared to legacy incumbents? We will see how that thesis plays itself out.
RZ: As volatility persists, strategies that invest in highly cyclical, single-product companies with high customer concentrations may be challenged. With inflation at the highest levels seen in decades, the ability to pass through price increases based on the stability of demand and the company’s competitive positioning will also be a key factor when considering the credit risk [a company/an issuer]. Additionally, investing in regions with limited bankruptcy protections may prove to be difficult if there is a turn in the credit cycle over the near-to-medium-term. Certain geographies with less robust creditor protections and restructuring precedents can prove challenging when seeking to enforce contractual claims on assets or businesses.
We’re about to launch the search for a new set of rising stars. What advice do you have for anyone looking to establish themselves in the private debt industry?
NC: Think outside the box. Private debt has been stagnant for a long time. Be a student of markets and take cues from other financial services firms that push the envelope on innovation. Find ways to revolutionise the market and do something new, because the opportunity is there in private debt, so much more so than any other market in financial services.
RW: Whether you’re a private debt fund manager, an investor or consultant allocating investment capital to private debt managers or a third-party adviser, your primary constituency is obviously of paramount import, but you’re a part of the larger ecosystem. Don’t chart your career single-mindedly. Invest your time and talent in the greater ecosystem, in constituencies that aren’t yours directly. What you do to benefit the industry as a whole benefits your profile.
RZ: Volatility presents an exciting opportunity for junior professionals in the industry to build a deeper understanding of relative value and the importance of asset selection and deal structuring. Learning from senior colleagues who have experienced prior cycles and getting as much exposure as possible to a wide range of opportunities across the capital structure are great ways to develop an appreciation of how to price risk. In turbulent times, patience can also be a virtue.
Where do you see private debt in 2032? How will it have changed?
NC: The sheer volume of deals and amount of capital being raised make one-off transactions unsustainable. Market and data structure standardisation and transparency are inevitable, as is more regulation of non-bank lending.
Technology becomes the critical differentiator as private debt will largely resemble its public counterpart, remaining ‘private’ in format and name only. As private debt becomes more efficient, it becomes all the more appealing. There is margin to be realised in capturing these efficiencies, and demand from all parties will only serve to drive continued growth.
RW: I’m not smart enough to publicly prognosticate, but I wonder if the information asymmetry and relative inefficiency of the private debt markets will narrow to the point that the private and public debt markets converge in many ways. With new, innovative product offerings, especially in connection with the democratisation of alternative assets, we may see increased liquidity in exposure to (what we now call) private debt.
RZ: While difficult to see exactly how the market will change, the continued strong growth of the overall private debt market seems inevitable. With that growth, the largest platforms are likely to benefit from their scale, with opportunities accruing to the bigger, more established managers in the market. Separately, with ESG becoming a key theme in recent years, sustainability factors are expected to become increasingly important components of managers’ investment decisions over the next 10 years.
Do you know a Rising Star of Private Debt? We’ll announce our 2022 list of 40 future leaders of the asset class on 1 November 2022. To be eligible, nominees must be under the age of 40 when the list is published. Cast your votes by 2 September 2022 and if you have any queries reach out to email@example.com.