Future of private debt: The big 'what ifs'

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WHAT IF IT’S DONALD? OR HILLARY?

No conversation on the future of private debt would be complete without a discussion of the 2016 US presidential election, which may be a fool’s errand given the opacity of potential private credit regulations.

On their websites, Donald Trump and Hillary Clinton present little that deals exclusively with private debt. For his part, Trump espouses general platitudes about opposing regulation. Clinton provides more specifics, but only mentions regulation of non-bank financial companies, what the Democrat’s campaign calls “shadow banking”, at a 40,000-foot view.

Neither campaign returned requests for clarification or elaboration on their candidate’s favoured policy prescriptions.

Among market sources, sentiments vary. One told PDI that it was difficult to tell with certainty what an administration of either candidate would do. The source, though, did posit that a Clinton administration could be a hybrid of policies from both President Barack Obama, known for cracking down on Wall Street, and Bill Clinton, a champion of deregulation while in office.

A second source said a Clinton administration could be more favourable to the industry, as she is more likely to continue the Obama-era policies of stricter federal oversight of banks, continuing or even accelerating the retrenchment of traditional, regulated lenders.

Both candidates, at one point or another, have promised to get rid of the carried interest tax exemption, a favourite punching bag of candidates up and down the ballot. One market source said that a repeal of the provision would be of little worry to most private credit funds, even though many have carried interest provisions, because it is taxed as ordinary income. One exception could be for distressed debt investors, the source noted.

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WHAT IF OIL PRICES RISE?

Many private debt industry players have highlighted their limited exposure to an oil sector currently bedevilled by high existing debt, unsteady demand and a chorus of predictions that oversupply will hold prices “lower for longer”. Sentiment surrounding the sector has grown so gloomy that even a rise in prices from current levels of around $45 per barrel to $70 would have a limited immediate impact on lending, according to those in the market.

Such a price spike is most probable as the result of an event that disrupts physical supply, rather than any abrupt change in global demand or production policy. Under that scenario, of course, some lenders see opportunity in efforts to address that disruption. Lenders looking at the industry would welcome anything that provides support to prices that challenge the economics on many deals currently in the market.

Some firms that made loans in the sector while prices were high were not prepared for the depth of the price drop that started two summers ago and would remain reluctant to do new deals, even at $70 per barrel.

Alternative lenders to the oil and gas industry have traditionally focused on helping companies develop existing assets, as opposed to searching for new ones. Sources say some banks have been sufficiently burned by the recent cycle that they might never get back into energy. Some of the ground recently ceded to non-bank lenders in supporting acquisitions of existing assets would only be taken back under an even more dramatic scenario of prices surging to $150 dollars a barrel or more.

That said, in a future where oil prices have jumped that high, conditions for private debt providers would likely be a low priority on a list of the world’s biggest concerns.

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WHAT IF BRITAIN HAD VOTED TO REMAIN?

You wake up on 24 June. Nothing has changed. The UK’s 43-year long membership of the European Union has been soundly endorsed by a majority of the population. The status quo has been affirmed.

A number of reports and surveys prior to the vote noted that the uncertainty of the outcome was the main reason why many in the private debt industry were cautious. Deals were being postponed and limited partners held off from committing capital. But those hoping for a boost in activity if the vote had gone the other way may have been mistaken.

“A remain vote may have removed the uncertainty, but the wider macro environment has been volatile regardless of an alternative conclusion,” says Jacco Brouwer, head of debt advisory at AlixPartners. “Most credit funds operate pan-European funds and the unitranche product has been increasing in popularity across Europe. So, what happens in the UK is only part of the equation.”

The plunge in the pound leading up to the vote and on the day of the result, as well as drops in the FTSE 250, were seen by some as vindication of market fears about Brexit, but the recent recoveries are claimed by Brexiteers as proof that the UK can survive outside the EU. Both narratives are rushing too quickly to confirm their views.

Some assert that the slowdown in China and plunge in oil prices at the beginning of year had a bigger impact on deal pipelines than the Brexit vote. At the moment, it is too soon to tell what the impact of Brexit might be, but comparing what might have happened with what did happen should perhaps be left to the clairvoyants.