Investment banks, asset managers and hedge funds are increasing their presence in private credit markets as the demand for illiquid investments with higher returns than debt is generally expected to be expected. listed will increase rapidly in the years to come.
Global private debt assets under management more than doubled, from just over US $ 500 billion in 2015 to US $ 1.1 billion at the end of March, according to data provider Preqin, far exceeding rates of growth in government bond markets during this period. This happened as a growing number of institutional investors turned to less liquid credit exposures to meet yield targets in a world of low interest rates.
Alternative investment managers have tended to dominate private debt transactions, with the top 10 firms raising around $ 300 billion among themselves in the decade leading up to 2021, according to Preqin. But a larger cross-section of the financial sector is now investing heavily to carve out a niche in these booming markets, which have swelled over the past decade against a backdrop of declining traditional bank lending.
âThe private credit market is changing rapidly and continues to be an area of ââgrowing interest to our clients,â said Rehan Latif, head of credit operations and sales for EMEA and global emerging markets at Morgan Stanley. âWe expect it to be part of the overall leveraged credit ecosystem. In the zero rate environment, any sort of premium you want to capture will come from relative illiquidity. “
Private credit markets encompass a wide range of activities where investors lend directly to businesses. The primary focus tends to be funding for small businesses that could have used bank loans, but in its broadest sense, private credit can include funding for projects such as real estate or infrastructure, as well. as loans on assets ranging from trade receivables to aircraft.
Specialized investors such as Ares Management and GSO Partners have been active in private credit for years, allowing them to acquire higher yield exposures than those generally available in the public debt markets. The number of potential deals has only increased since the 2008 financial crisis, as tighter regulation forced banks to cut back on lending. Michael Dennis, co-head of European credit at Ares, said that when the company launched its European direct lending strategy in 2007, it would consider 100 to 200 potential investments per year. Over the past 12 months, he has reviewed over 1,100 transactions.
âInstitutional demand for private credit has increased dramatically over the past five to ten years,â said Dennis. âPrivate credit offers good variable rate returns at low levels of volatility. Additionally, as an asset class, it has demonstrated its resilience over the past 18 months during the Covid pandemic. “
Companies like Ares have no intention of ceding the hard-earned ground in these markets to banks – or other fund managers for that matter (see sidebar article). But the growing clamor from investors like pension funds and insurance companies for higher returns in the face of persistently low interest rates is undoubtedly prompting a wider range of financial institutions to seek their own niche in the market. private credit to meet these demands.
Top 10 investment banks on track to generate $ 400 million in revenue from private corporate credit this year, according to data firm Vali Analytics, which predicts the revenue pool will grow to $ 1 billion in 2022. .
âPrivate debt rivals the high yield bond market in size. But the amount of resources that investment banks have deployed for private lending is a fraction of the size of their high yield franchises, âsaid Sanjeev Mordani, co-head of global sales of spread product solutions at Citigroup. .
Fidelity International is an example of a mainstream asset manager who recently started his own private credit business. Earlier this year, he hired a private credit team from European lender MeDirect Bank and acquired a minority stake in specialist investment platform Moonfare.
âA number of key investors and key platforms are looking to consolidate and have fewer managers with a broader skill set. We are very keen to have these strategic relationships, âsaid Andrew McCaffery, Chief Investment Officer of Fidelity International.
âOur clients in the institutional and wholesale markets are faced with the question of how to generate a higher level of income given what has happened between competing financial assets. In private credit, you can give up a certain level of liquidity, but in many cases you have access to very good quality exposures and you get an improvement in yield, âhe added.
Hedge funds are also in the game. Christian Adler, a former senior trader at Deutsche Bank, co-founded Astra Asset Management in 2012 to focus on structured credit investments such as mortgage-backed securities and secured debt securities. Since 2019, Astra has been investing in private credit and is currently raising a fund dedicated to these exposures.
Astra has funded an electric vehicle company this year through an asset-backed loan and is looking to extend credit to social housing projects and the UK hotel sector, among other deals. Unleveraged returns on trades can range from around 5% to almost 20% depending on exposure and complexity, the hedge fund said.
âWe see a much more attractive pipeline of private debt deals right now,â Adler said. âPublic markets, whether CLO or RMBS, look pretty sparkling and there are fewer bids that match our target profile. “
At first glance, investment banks may not have such an obvious role to play in these markets, seeing private credit originally developed as an alternative to traditional bank lending. But a number of companies believe there are opportunities to create, negotiate, and finance private credit exposures.
Credit Suisse, which downsized its larger markets unit this year after suffering huge trade losses, has hired two former Goldman Sachs bankers – Charles Holmes and Yacine Bourezak – to step into that space. Barclays, Citigroup, HSBC and Morgan Stanley are among the many other companies looking to expand as well.
âDisintermediation is happening, but the strength of Citi’s network means there is enough business to seize,â said Rajiv Amlani, co-head of global sales of spread product solutions at the Bank.
He gave the example of a Citigroup client who had previously borrowed from private credit funds. The company was looking to raise more capital and asked the bank to embark on the operation. “We led the process and it created a lot of competitive tension,” said Amlani, who said the deal size rose from $ 150 million to over $ 500 million as a result.
One area in which banks see significant growth potential is in offering investors financing on private credit portfolios, given the demand from some clients to optimize returns. In contrast, buying and selling positions in secondary markets is currently not standard practice in private lending, although some bankers believe this could change.
âThis is one of the most favorable credit environments we’ve ever seen with low default rates. Private credit markets have only grown and the leverage in the system has increased, âsaid Latif of Morgan Stanley. “We believe clients will seek liquidity in the secondary market, either if markets turn around at some point or if spread compression continues and they wish to secure returns.”
Box story – The new credit giants
Ares Management raised the largest amount of capital for direct lending funds in the decade leading up to 2021 at $ 37 billion, according to Preqin – roughly the same as the other three largest companies combined.
The sheer volume of money devoted to private credit allows these managers to encroach more and more on the core business of investment banks of underwriting bond and loan sales in the effect capital markets. the sink.
Last year, Ares was the lead arranger of a Â£ 1.88 billion financing to UK insurance broker The Ardonagh Group in what he called the biggest unitranche deal ever. . In August, funds managed by Ares’ European Direct Lending Strategy were the only lenders of Â£ 1 billion of credit facilities to engineering and environmental firm RSK Group, which Ares said was the largest private financing ever backed by credit and linked to sustainable development.
âAs private credit funds became more important, we began to compete in traditional capital markets for high yield and syndicated loans – an area that has been the domain of investment banking,â he said. said Michael Dennis, co-head of European credit at Ares. âWe manage funds that give us the scale to be more relevant than ever to large companies. Three to five years ago some of these transactions were only executed in capital markets – private markets didn’t have scale – but that’s changing. “
Dennis said there may be more competition for transactions in parts of the broader private lending world, but in direct lending, Ares believes incumbent managers like him have a significant head start.
âIt’s a very resource-intensive and relationship-oriented company,â he said, noting that Ares has a direct loan team of 75 people across Europe that creates opportunities. âThe barriers to entry are very high. We have a portfolio of over 150 names in Europe and 40% to 50% of our capital deployment each year relates to our existing portfolio companies. If they need capital, we are often their first port of call.
Asked about warnings from some quarters about the growth of private credit markets potentially creating systemic risk, Dennis noted that his team only concludes about 3-4% of the roughly 1,000 transactions they typically review each year. He also said that around 90% of their transactions involved senior assets with a commitment. âWe are at the top of the capital structure,â Dennis said.
Others pointed to the good performance of private lending in the turbulent markets of 2020. “The private business lending asset class has held up incredibly well last year during the pandemic,” said Mitali Sohoni, co-head. global asset financing and securitization at Citigroup. “Asset managers have worked with sponsors to provide significant support to the companies.”