Almost 200 of the private debt industry’s great and good gathered in London last month to celebrate the official launch of this publication. Kindly hosted by SJ Berwin at their London offices, the event began with a panel discussion before a chance to network over drinks.
The panel featured: Ian Borman, partner and co-head of International Finance at SJ Berwin and fellow partner Duncan Woollard; Andrew McCullagh, partner and co-head of primary lending at Hayfin; Dagmar Kent-Kershaw, head of credit fund management at ICG; Babson Capital Europe managing director David Wilmot; and Fred Nada, head of research for credit alternatives at BlueBay Asset Management.
In a wide-ranging discussion that featured a number of questions from the assembled company, the panellists discussed the development of private debt as a distinct asset class, and reached a few conclusions.
First, the banks still matter. They always have done, and always will do. They may be lending less, particularly in smaller segments of the market; they may be more risk averse, and willing hold a little less and syndicate a little more; but they’re still there financing deals. However, a relatively small reduction of their overall lending activity in percentage terms equates to a massive opportunity for alternative debt providers. The need for financing has never been greater, and private debt has a major, and growing, role to play.
There are some definitional difficulties however with private debt. “Debt fund”, it was agreed, didn’t do the job. There are too many differing opinions as what falls into that category, so you need more precise labelling for your fund if it’s to make sense to investors.
One audience member asked if there were too many debt funds in the market at present. The response from the panel was a resounding no. If anything, there are too few, they said. This is a situation likely to worsen, as liquidity is lost from the market once large numbers of European CLOs reach the end of their reinvestment periods. Yes, there’s been a resurgence in CLO activity in Europe in recent months, but it’s a drop in the ocean in relative terms.
Another question concerned the use of leverage at the fund level. None of the panellists’ funds employed fund-level gearing, but plenty of funds do. That practice came with a warning though – the majority of investors would prefer funds not to be leveraged, as it simply adds an additional layer of risk.
An interesting point raised concerned the perceived unfair playing field on which banks and private debt funds compete for deals. The argument ran that for a private debt fund looking to put capital to work, the odds are stacked against them. The reason? Banks (in some cases, but not all, ‘the opposition’) are typically the repositories of a vast amount of knowledge regarding the assets they loan to and service, and are therefore in a much better position to judge their credit-worthiness.
As such, there’s potentially a lingering doubt that when invited to underwrite loans against an asset, a private debt fund might just be picking up a credit that the bank itself has passed on. “Debt funds face an adverse selection risk, which can be quite humbling,” Hayfin’s Andrew McCullagh insisted.
Some firms make a virtue of this of course, and actively seek out challenging situations that the banks have or would baulk at. One point made subsequently however was a good riposte: the individual, a private debt manager, argued that this uneven playing field thesis presupposes that banks not only have more information, but also that they use it effectively and efficiently.
“If anything, it’s the lack of that which is how banks manage to get themselves into trouble so easily. Banks – more so as they become bigger – fight the same problem governments do: they don’t know what they know. They are political, internally territorial, and inherently ineffective at taking the information they have in one place and deploying it elsewhere, if they even manage to figure out in the second place that their own team elsewhere knew something in the first place.”
The point being, private debt funds may not have access to as much data on a potential credit as a bank, but they know how to use what they do know more effectively.
Lastly, there was a lot of speculation as to the health of the mezzanine market. Given we devote several features to the topic later in this issue, there’s no need to cover the same ground here. Suffice to say, there were some trenchant views expressed, whilst the consensus appeared to be that while challenged, the mezzanine market could still be profitable for skillful firms.