Year ahead: Which direction now for private debt?

Towards the end of 2016 and in the early weeks of the new year, PDI was busy canvassing the market to try to shed light on what challenges and opportunities the upcoming period may present.

The background signals are undoubtedly looking good, with further strong growth for the asset class tipped by many. “The outlook for 2017 is positive for private debt providers,” says Paul de Rome, a partner at fund manager EQT Credit. “Smart investors in credit will be able to benefit from the uncertainty and volatility caused by the end of the multi-decade super-cycle for credit, asset prices, globalisation, demographics and politics.”

Ken Goldsborough, managing director at valuation and corporate finance firm Duff & Phelps, expects continental Europe to grab a larger slice of the action. “We’ll see a continued shift into non-bank lending in the remainder of Europe, particularly France and Germany. Europe is slowly moving towards the US model where non-bank lending makes up approximately 80 percent of the leveraged finance market.”

In Asia, where investors were arguably slow to recognise the private debt opportunity, disappointment with private equity returns may encourage more LPs to consider private debt instead. “Historically, LPs have allocated to credit opportunistically, whereas today credit has become a strategic and important component in most portfolios,” says Enrique Cuan, managing partner at placement agent Mercury Capital Advisors. “These allocations are only going to get bigger.”

With the inauguration of President Donald Trump, attention in the US has turned to whether the new regime will scrap regulations that have aided the rise of alternative lenders as banks retrenched.

Ken Kencel, president and chief executive of credit manager Churchill Asset Management, does not expect a bank comeback. He thinks Trump will undo regulations on business and community banks, specifically on credit cards, auto loans, mortgages, student loans and consumer loans – areas beyond the wheelhouse of most credit investment firms.

“These are areas where the middle class – many of which voted for Trump – are more focused,” notes Kencel. “We think that will be the regulatory focus of the new administration.”

Comply or die

In the collateralised loan obligation market, the dawning of 2017 brought with it a major regulatory change in the form of new risk retention rules, demanding that CLO sponsors hold a 5 percent interest in the credit risk of securitised assets. Towards the end of last year, many managers were busily assessing ways of achieving compliance, with most opting for the so-called majority-owned affiliate structure.

Unsurprisingly perhaps, Fitch Ratings predicts in its 2017 outlook that CLO issuance in the coming year will be dominated by larger managers that already have risk retention-adherent solutions set up. Others are still in the process of looking for ways to fund risk retention investments.