Echoes of the crisis

Earlier this week, we gathered a collection of asset class experts in London to give us their views on the latest key trends in European private debt. The results of this roundtable discussion will soon be shared in full but, in the meantime, we can relate a few of the observations.

It won’t come as any surprise to learn there are concerns. In recent interviews with LPs, we have been asking whether they see any signs of crisis-period excesses in today’s market and it’s clear – from this conversation, for example – that some certainly do.

During the roundtable, reasons were given why investors are thinking back to those apocalyptic days. The level of competition is considered to be intense and coming not just from new private debt managers but also from border raids from outside the asset class – hedge funds have been particularly active in parts of the market.

One participant mentioned that fund investment period extensions are being increasingly granted, often adding around an extra 18 months to a typical original timeframe of between three and five years as GPs seek refuge from a heated market by buying themselves more time. LPs initially pushed back but many are now relenting.

Again, no surprise that they are. Deal terms are very aggressive and, with covenants fast disappearing (and ‘lite’ and ‘loose’ making their way steadily down the deal size ladder), the point was made that cashflow issues could soon be seen in some businesses – and with an accompanying shock factor produced by the absence of any meaningful early-warning system.

The UK was cited as a market where problems may hit sooner than elsewhere given the prolonged uncertainly around Brexit and growing inflationary pressures – especially in the consumer-facing industries that many lenders are heavily exposed to in the country. And the UK, remember, is by some margin Europe’s largest private debt market.

There was some optimism expressed, not least around leverage levels – considered to be conservative compared with the pre-GFC years. This has been enabled by very large equity cushions in many deals, meaning that risk has arguably been nudged more to the equity than the debt side of the equation.

Equally, there was scepticism around definitions of EBITDA and a sense that the debt/EBITDA multiple is subject to manipulation and little more than a form of smoke and mirrors in extreme cases.

With increasing recognition that a turn in the cycle is unlikely to be far away, there is some anticipation of whether/how the asset class may be reshaped as a consequence. One prediction is that responsibilities within fund managers may become more siloed/specialised as the difficulty of combining restructuring and recovery work with new deal activity becomes difficult to reconcile.

A second, intriguing suggestion is that the yet-nascent private debt secondary market may receive a boost as funds finding themselves unlikely to hit return targets look to sell out rather than fight losing battles. Herein lies an important point: a downturn could help certain parts of the asset class to flourish. In private debt, someone’s challenge is another’s opportunity.

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