The future of private debt: Industry perspectives

OUR INDUSTRY PANEL

James Newsome, managing partner at Arbour Partners

Tavneet Bakshi, partner at First Avenue Partners

Antoine Josserand
, EMEA head of international fund distribution at Citigroup

Bill Troup
, managing director of the debt advisory practice at Livingstone Partners

Charles Le Cornu
, head of division, private debt and capital markets at Sanne Group

Q Which upcoming opportunity in private debt do you think is the most exciting?

James Newsome
: Private debt funds issued by the top market-place lenders. Amortising loans to thousands of SMEs with a long operating history can be accessed in one fund through these platforms now. Yields are equivalent to those in less granular, traditional PD funds.

Tavneet Bakshi: Shorter duration special sits lending, consumer NPLs.
Antoine Josserand: Speciality and asset-based lending, where there is a clear tangible asset or a well-defined opportunity set, especially in terms of the asset risk you are taking on, are extremely interesting; but the same applies to “new” emerging strategies, such as trade finance and royalties to name a few. While these financing solutions have been the forte of banks for many years, they are now being offered by niche asset managers to institutional investors.

Bill Troup:
Most elements of the capital structure are well served currently, so debt managers raising senior debt funds aimed at traditional, safer structures with lower returns could be
interesting. This could broaden lenders’ origination opportunities in a highly competitive market.

Q: What do you think is the greatest challenge facing private debt?


JN:
Retaining underwriting quality as the market expands.

TB:
Overlevered structures and challenged deployment rates.

AJ: The sheer amount of capital that has been raised, and the implications this has for
deployment, ramp-up and portfolio diversification for investors. There is a possibility that managers can end up over-transacting in a particular sector or geography and deliver highly concentrated portfolios to their investors as a result.
Alternatively, managers might be tempted to lend in larger-sized transactions to be able to deploy capital fully and end up being less selective.

BT: A key challenge is the amount of dry powder in the market relative to the opportunities to deploy, and the pressure this puts on managers with fees focused on deployment. On the positive side there is increasing acceptance of direct lending
by sponsors who have historically felt more comfortable with traditional lenders.

CC: Aside from regulatory change, continued strong fundraising and record numbers of new funds entering the market – while being very positive in some respects – does raise questions as to whether there are sufficient opportunities for managers to put capital to work and also whether returns will be driven down by the level of competition.

Q: Which region or strategy do you think is the most promising

JN: Private Northern Europe and the US remain the most promising regions.

TB: Asia credit is still early in its evolution and would be one to watch long-term, though risks in China debt markets and any contagion are high and still rising.

AJ: Mezzanine in the US and unitranche and senior lending in Europe. The former because of the depth of the corporate market in the US, which lends itself well to achieving relatively higher but risk-adjusted returns through investment discipline. The latter trend is due to the lack of standardisation of the European corporate market, where the majority of senior lenders are more likely to successfully navigate various lending regimes. Also, as investors have become more comfortable with the asset class, we are seeing specialised and niche strategies attracting more interest but capacity remains limited.

CC: The vast majority of private debt funds are raised in North America with capital deployed locally. In terms of trends, we are seeing increased investment into Asia as activity in the region continues to develop.

Q: Which technological trend do you think will have the biggest impact? 

JN: Blockchain technology – a potential distributed ledger of all credit transactions
– has tremendous implications for sourcing, underwriting, KYC, smart contracting and credit work-out.

TB: Increasing institutionalisation of the online lending platforms; blockchain-based distributed register/ledger – the two together would be game- changing.

AJ: The proliferation of platforms like the mini- bond market in Italy can play a role in reshaping the market. However, documentation, credit assessment and monitoring, and enforcement issues persist in this construct and we don’t expect this to change in the medium-term. Likewise, platforms are becoming critical players in the trade finance/factoring sectors, especially with respect to sourcing assets.

CC: Enhanced systems capability offers increased transparency to fund managers and their investors. As such, the tried and tested quarterly reporting cycle will be phased out, with a move to ‘real time’ data being more prominent. Therefore, dynamic reporting capability utilising portal technology for remote access for private debt fund managers and their investors will be key.

Q: What one piece of future advice would you offer fund managers?

JN: “History doesn’t repeat exactly but it rhymes.”

TB: LPs are increasingly looking for differentiated sourcing, so invest in origination capabilities; be focused on your USP and flexible on terms and formats for doing business.

AJ: Managers need to be realistic about the size of fundraising opportunities against expectations on deployment of capital, and be highly transparent on the latter in investor communications. Given the popularity of the asset class, managers in the private debt spaces should avoid the curse of some hedge fund managers before the crisis when AUM was growing significantly and “style drift” became an easy fix to handle higher AUM.

BT: From a borrower’s and advisor’s perspective a key attraction of direct lenders is their flexibility and creativity around funding structures. And they are prepared to pay for it. Managers who continue to perform well on these points are likely to do very well.

CC: Ultimately, outsourcing is becoming more prominent due to increasingly onerous regulatory regimes, an increased compliance burden, with transparency requirements driving the need for ever increasing systems capability. As fund structures become increasingly jurisdictionally diverse and complex, partnering with an outsource service provider that can provide the full suite of services in multiple jurisdictions will become exceptionally important.and complex.