Preparing for another big year

It’s been a big year for private debt. An array of firms raised large amounts of capital, much of which was not deployed, leaving some general partners with plenty of dry powder.

Take Blackstone’s credit arm. GSO Capital Partners holds $20.16 billion in undrawn capital, according to its third-quarter earnings report. Of Oaktree Capital Management’s $22.7 billion in dry powder, $8 billion comes from its Opportunities Xb distressed debt fund, regulatory filings show.

A Deloitte survey on M&A activity showed that 75 percent of practitioners polled expect to see an increase in deal-making in 2017, including 86 percent of private equity professionals. One market source who works on sponsored transactions thinks the increase could be to the tune of 10-15 percent.

That bump, the source says, would help firms use up their excess capital, creating favourable conditions for putting companies on the block. In addition, the market is having a better end to 2016 than it did to 2015, the source adds, meaning M&A has a “running start” into 2017.

According to the Institute for Mergers, Acquisitions and Alliance, 2015 saw near-record deal-making, the highest since 2007.

What’s more, limited partners’ increasing comfort with private debt means large allocations. Last year saw more than $106 billion raised for private debt globally, while a further $67.4 billion had been collected by the third quarter of this year.

Moreover, assuming those funds deliver expected returns, the potential exists for even larger allocations in future. After all, the basic argument for the asset class can be summed up succinctly: in a perpetually low-yield world, private debt can provide solid downside protection along with reasonable yield.

The US election result will be another force in play during 2017, particularly for business development companies. With the election of Donald Trump and the Republicans retaining strong majorities in Congress, the GOP is set to fully control legislation for the first time in a decade.

Republicans have traditionally been the party advocating for lighter regulation on business, though it should be noted that President-elect Trump hardly campaigned as a cookie-cutter Republican.

Regardless, total GOP control may mean BDCs are allowed to increase their use of leverage. Currently, these types of lenders have a debt-to-equity ratio limit of 1:1, which would increase to 2:1 under proposed legislation.

The BDC bill passed the US House of Representatives Financial Services Committee in November 2015, having faced opposition from Mary Jo White, chairwoman of the US Securities and Exchange Commission. Most BDCs have a leverage ratio of less than 0.9:1.

The legislation’s effect could mean a bigger divide between BDCs. Those companies with stock trading above net asset value per share can issue equity without diluting current shareholders. More equity obviously increases the amount of debt a firm can take on. Throw in the higher leverage limit and the amount of capital a given BDC has available to it might even be more dependent on its market position.

In 2016 more firms have entered the private credit space and more LPs have committed capital to the asset class. Come 2017, M&A activity and the BDC legislation before Congress may be the two developments to watch.