1. After the peak
Last year was a record-breaker for the private debt industry. North America-focused funds – a group comprising vehicles largely focused on the US – accounted for a third of all activity, with $74 billion raised. This was close to the $78 billion gathered by multi-regional funds. North American funds only surpassed regionally agnostic vehicles four times in the past decade – the last time was in 2015.
In the first half of 2018, North America-focused fundraising reached $20.1 billion, overshadowed by the $30.3 billion raised by multi-regional vehicles and $20.5 billion gathered for Europe. The only time Europe-focused fundraising surpassed that of North America was in 2012. Then, as now, this was largely due to a handful of giant fundraises. North America-focused funds still account nearly half of all fund closes globally in 2018 – 37 out of 81.
2. Distress in decline – for now
Our 2017 annual report tells us distress debt fundraising has been on the rise globally. The main driver has been the comparatively immature European market. North American private debt, by contrast, has seen distressed debt strategies dwindle in the years following the financial crisis.
There are two interpretations for this. The first is that we are seeing evidence of a more mature market. Lenders and borrowers are better insulated against volatility, which means fewer distress opportunities. During the crisis, distressed-focused vehicles accounted for nearly a third of all fundraising – $11 billion of a total $35.5 billion in 2008. In 2017 they accounted for less than 10 percent – or $6.8 billion of a total $71.2 billion. Secondly, it is worth remembering that this market is cyclical. The strategy is likely to rebound as the cycle turns. Given that North America-focused distressed debt vehicles account for a quarter of all capital targeted by funds in market, this shift could be imminent.
3. Giant country
We have seen several headline-grabbing fund closes in recent years. The most recent were GSO Capital Solutions Fund III ($7.12 billion) and Broad Street Real Estate Credit Partners III ($4.2 billion), both of which closed in the first half of 2018. Anecdotally, many in the market have described an increasing bifurcation of the industry. Private debt has become more polarised as larger generalist funds consolidate and expand their reach, leaving niche players to fill the gaps.
The phenomenon has been seen in other alternative asset classes too. It comes as little surprise then that the average fund sizes have been drifting upwards over the past decade. The number may have waxed and waned on occasion, but overall it is an upward trend. A new high of $628 million was set in 2017, while this year has been a close second so far.
4. Deal pressure
From record-breaking fundraises to creeping EBITDA multiples, there have been plenty of warning signs that we may be headed for another downturn. Perhaps one of the starker omens in the private debt industry has been the growing proliferation of covenant-lite loans. Covenants act as warning signals alerting lenders that all may not be going entirely to plan in a business they are backing. However, in a borrower-friendly market, these protections have become looser as managers compete for deals.
According to information provider LCD, cov-lite transactions now account for around three-quarters of outstanding US leveraged loan volume, up from about half in 2014, and one-third pre-crisis. While the point has been made that these deals have not defaulted any more frequently than loans with traditional covenants, the amount of cov-lite loans is unprecedented. However, many in the industry will be keen to point out that loose terms have mostly been a feature of the upper mid-market. US managers are increasingly eager to emphasise their focus on the traditional – or core – mid-market where protections are stronger.