With banks continuing to face pressure on capital, and increasing regulation, the provision of private debt – often to companies owned or sponsored by private equity – has been one of the fastest-growing parts of the capital markets for more than a decade. It now actively competes with more established funding routes such as syndicated loans and high-yield debt: all three are USD 1.5 trillion markets and private debt is forecast to reach at least USD 2 trillion by 2027, according to Moody’s Investors Service.
John Popp states that although that each of the three asset classes noted above will at times offer better value to borrowers, there is little sign that interest in private debt as a source of funding is waning. “We think all three markets will continue to co-exist and compete for capital. Sponsors have become increasingly sophisticated in comparing the relative attractiveness of these markets and will continue to work to optimize the borrowing costs of their portfolio companies,” he says.
Baxter Wasson adds that borrowers can prefer dealing with a single lender, as is often the case with private debt deals, particularly if they are tapping the market with a highly structured transaction, the loan is tied to a merger or acquisition, or they are anticipating a potential future restructuring. As well as providing discretion, these bilateral private deals also reduce mark-to-market volatility, he says. “Lenders may also favor private debt because they tend to have more protections in those deals and in a volatile market those protections matter more,” he says.
Indeed, there are indications that the private debt market is set to grow even more rapidly. As a further boost, Popp argues that regulators should prefer institutional investors over banks as lenders. “From a policy perspective, I do think it is better to have risky assets owned by funds that are matched duration and with investors that have long-term hold outlooks such as pensions, sovereign wealth and insurance companies,” he says. “A bank by its nature is levered more than 10 times and weighted with short-term liabilities. We therefore believe the bias will be against lending to small and medium-sized businesses, by regional banks in particular.” A good structure for investors here may be pooled loans, or collateralized loan obligations.