US Special: America takes a pause for breath

The sidelines have been a crowded place this year and it appears that some investment funds might be staying there for a while. Investors are pouring money into private debt funds in hope of higher yields in a seemingly never-ending period of low interest rates, but a decline in leveraged loan issuance, CLO and LBO activity, and private placements is leaving that capital competing for too few good deals.

“We’re finding that deal volumes continue to languish past periods, due to slow to negative growth in global economics and the absence of strong economies,” says David Brackett, a managing partner and co-chief executive of Antares Capital.

However, investor interest in the US private debt market remains strong.

“The Bank of England just cut interest rates to a historic low and real interest rates in most parts of the world are negative, so investors are looking at the US,” says Brackett, adding that global conditions make yields in the 5.5-6 percent range attractive to investors unable to get such returns through traditional fixed income allocations.

In their search for yield outside of traditional bonds, investors across the globe have been piling into private debt funds with $46.1 billion raised in the first half of this year across 69 funds, according to PDI data. And the top 30 managers in the PDI 30 ranking this year continue to collect more and more.????

While fundraising appears healthy many expect that some of that money will remain in limbo until market volatility stabilises and leveraged loan issuance picks up. Some senior debt managers also tell PDI they are increasingly cautious about making new deals at a late stage in the credit cycle.??

“There has been voluminous intervention by central banks that has basically lengthened and distorted the debt cycle,” says one fund of funds investor whose investments are focused on the credit, event-driven and distressed debt markets, pointing to recent efforts by Switzerland’s central bank, the Bank of Japan and the People’s Bank of China to artificially stabilise their respective countries’ economies.

“It all creates a lot of uncertainty as to how we get through this environment that was created by overly generous monetary policy just to try to stimulate the economy.”

That uncertainty is evident in the number of private debt deals that have been completed this year.  According to Thomson Reuters, global private debt placements totalled $22.1 billion in 96 deals for the first half of 2016, compared with $25.8 billion in 112 deals for the same period last year. Of that activity, 57 deals totalling $13 billion were completed in the US in the first half of 2016, compared with 66 deals totalling $14.8 billion a year ago.??

Energy remains the most active sector, despite the effects of low oil prices. In the first half, 25 deals were completed totalling $4.8 billion, compared with 31 deals totalling $7.4 billion for the same period last year, according to Thomson Reuters.

Though the high-yield energy market has risen in recent weeks, investors are uncertain how long it can remain there, noting that if the market again moves in tandem with the price of oil the unwary could be caught out. ??

ADD-ONS ADDING UP

While pockets of activity have popped up around businesses looking for greater efficiencies, for the most part investors are being fairly cautious about committing capital.

“To the extent that it’s hard to grow your business in terms of revenues, add-ons allow you to take cost out of your business,” says Antares’ Brackett. “And we’re seeing a lot of add-on acquisitions.”??

One noticeable change within the US credit market is the increasing use of financing clubs within the mid-market space, as opposed to syndicates.

“If I see one more private lending fund I might lose it,” says Michael Hennessy, managing director of investments at Morgan Creek Capital Management. “It’s the soup du jour and, theoretically, it sounds good. But with many of these guys it is just a bidding and auction process and there is very little value add.”

The interest in finance clubs is being largely driven by investors shunning the large syndicates typically put together by banks in favour of smaller groups targeting mid-market deals.

Investors are also being attracted by adjustments to traditional collateralised debt and loan obligations which see them accept lock-ups. Given that panicked investors often redeem at the first sign of market volatility, lock-ups ensure that such funds have the time necessary to ride out turbulence.

“There are some really interesting CLO deals and funds out there. You just have to be with the right team and make sure it’s the right fund structure,” says Hennessy.

Though investor interest in US private debt remains strong, uncertainty in the markets is keeping funds from aggressively putting the money they have raised to work. From fears about the outcome of the US presidential race to questions about how Brexit will play out once the UK begins the process of leaving the EU; mixed thoughts regarding when the Fed will start raising interest rates; and even worries that the US is heading towards a recession, there are numerous factors concerning investors. ??

“If the economy does slow, and a lot of people are thinking it will, it will have an impact on the valuation of new deals on the private equity sponsor side,” says Michael Ewald, managing director and head of Bain Capital Credit’s private credit group. ??

“A lot of deals are currently clearing in the 10 times (EBITDA)-plus range. But if you’re a private equity sponsor looking to buy right now you’re thinking, ‘I can’t get the returns I need if things are going to slow to a single digit range, so I’m only willing to pay eight times the value,’” he says, adding that this sort of mindset has already begun to impact new deals in the market.