Five years of private debt: The new relationship lenders

PDI celebrates its fifth birthday this month. In that time, private debt funds have made a huge impact, striding further into territory vacated by the banks. Andy Thomson reports

In the five years since PDI began covering the global private debt markets, a transformation has gathered pace. From banks being recognised as ‘go-to’ lenders and then forced into retreat by strict regulation and their own balance sheet pressures, private debt managers have staked a claim as the default relationship lenders of today – their flexibility and speed of execution prized by borrowers.

To place recent developments in context, Robin Doumar reaches as far back as 1997. Now managing partner at Park Square Capital, the London-based private debt manager, Doumar was then the newly appointed head of Goldman Sachs’ European leveraged finance business and appointed to advise on private equity firm Cinven’s £860 million acquisition of IPC Magazines, a combined bank finance and bond deal.

“In those days, the market in Europe was banking finance and a nascent bond market, and both were dominated by the banks,” reflects Doumar. “For a €1 billion loan you typically needed four or five banks and, although they had the option to syndicate to smaller banks, many could hold €250 million tickets on their own balance sheets.”

For those wishing to take a position in the capital structure, there was no point competing at the senior end. “The notion of competing for loans with aggressive banks made no sense,” says Doumar.

Indeed, by the time he had concluded his career with Goldman and launched Park Square in 2004, junior capital was still the only game in town for non-banks. “When we started, junior debt/mezzanine was all there was,” he adds. “The first movers in private debt were all focused on junior capital.”fund ma

Credit pickers

Around 10 years ago, Doumar says, Park Square began moving into senior debt as the aftermath of the financial crisis and Basel regulations nudged the market away from large ‘take and hold’ positions. However, this transition was on the back of a strong syndication market in which success for fund managers such as Park Square hinged on their ability as credit pickers.

At that time, direct lending was still not on the radar – but it’s in that direction the market has moved over the last five years. “We now have a lot of senior and junior debt with a lot of borrowers and a portfolio of businesses which provide spin-off opportunities,” says Doumar. “The borrowers don’t have to go to the banks, they can speak to us directly. As the portfolio has got larger, we have become the relationship lenders to the LBO community.”

“The last five years have been fascinating,” says Andrew Konopelski, partner and head of EQT Credit and previously a member of the leveraged finance team at Citigroup. “It’s been a period where private debt has really grown up in Europe. People still talk about Europe being behind the US, but things have been going strongly in the right direction and there is a growing acceptance of how we complement the banks.”

Konopelski reflects that fund documentation in the mezzanine market was “quite constraining”. One of the big changes he has observed has been the transition to more flexible capital solutions. “Rather than what used to be a cookie-cutter approach, the last three or four years have been about providing solutions to financing needs.”

In agreement with Doumar, he adds: “What’s really changed is the growth of direct lending as an alternative to bank lending. It’s proved itself a viable product and has filled the gap between the mezzanine guys and the CLO guys – a gap which used to be so big you could have driven a truck through it.”

The evolution of private debt can also be seen through the prism of investor allocations. Go back 10 years and capital came either from alternatives-focused teams, expecting something with a higher risk and return than private debt typically offered, or fixed income teams expecting quite the opposite at the lower risk and return end of the spectrum. Private debt found itself stuck between a rock and a hard place.

“There was a huge disconnect,” acknowledges Konopelski. “What really drove the increased interest from LPs was the emergence of private debt-focused teams five to seven years ago. Initially, these were effectively joint ventures between the fixed income and alternatives teams, which came together and formed a complementary bucket for that 7-11 percent return range.”

Pulling power

Faisal Ramzan, a partner at law firm Proskauer, says changes in the market have been reflected in the shifting identity of the key group he practices in – presently known as the private credit group but previously known as the junior capital group and, further back, the mezzanine group. “We have evolved along with our clients,” he says.

Reflecting on the record $180 billion raised by private debt funds globally last year, Ramzan says one of the obvious changes over the last half a decade has been private debt funds’ increasing pulling power. “The sheer size of funds being raised by managers now into their second, third or fourth funds in the series is amazing,” he says.

“That has a material impact on their ability to underwrite and arrange larger deals and also to form clubs and do very large deals alongside other funds, the magnitude of which were unheard of four or five years ago.”

But what of the next five years? In 2023, what further developments will we be reflecting on in these pages? Konopelski believes fundraising will becomes less siloed as investors increasingly focus on the ultimate outcome. “It will be about tailor-made solutions, especially for large investors,” he says. “The aim will be to blend multiple strategies to hit a target return.”

He adds that obsessing over strategic approaches will become less of a concern than simply having faith that the capital is being placed in the hands of the right managers. “Investors have by now become more familiar with the personalities and idiosyncrasies of different firms and more comfortable with how and where they invest. It will increasingly be a case of ‘I trust you with my money – here it is, invest it well’.”