Studies: Private credit premium possibly under pressure

Managers of credit strategies will have to add value and make savvy investments as market liquidity, in part driven by their own fundraising success, threatens to compress the illiquidity premium in 2015.

A slew of recently published reports and market analyses confirm that 2014 was a strong year for private debt funds. But questions remain about the sustainability of the return premium that has attracted so many into private credit.

Standard & Poor’s released a report focusing on the growth in alternative lending for mid-market companies in Europe. The ratings agency found that issuance of private funding for companies in Europe grew to over €38 billion in 2014, including private placements and direct lending.

At the same time, a separate report from advisory firm Altius Associates pointed to one of the biggest issues facing private credit strategies this year, whether the return premium over liquid credit markets can be maintained. It estimates that the illiquidity premium has been between 300 and 400 basis points for several years.

Asset manager and private lender Partners Group has also published its Private Markets Navigator, which digests the firm’s outlook for its various investment markets in the first half of 2015.

Chris Bone, managing director and at Partners Group, said that the premium earned on lending to mid-market borrowers that the private funds focus on is unlikely to compress. He added that in the larger syndicated market, margins have ebbed and flowed in response to liquidity and external market factors, but that the outlook for 2015 did not suggest aggressive compression is in the cards.

The Partners Group report acknowledged that the larger cap credit markets were awash with liquidity in the first half of 2014. But the firm’s own credit strategy is posited on the view that there is value to be found in lending to middle-market companies that do not have access to the high-yield bond market and niche sectors will more limited access to credit. In 2015, the firm will focus on those two areas, as well as bringing extra value to potential borrowers by structuring deals creatively, the report says.

The Standard & Poor’s report estimated that the European direct lending market provided €10 billion in credit across more than 200 deals in 2014: up from about €5 billion a few years ago.