The February 2014 SuperReturn conference for the first time had dedicated a whole day to private debt ‚Äì with a standing-room-only audience attesting to the significance that the asset class is achieving. The audience of 160 heard the most¬† active private debt GPs, LPs and placement advisors in Europe discuss the latest market developments.
The day started with an overview of the private debt space which focused on the dynamic that although banks continue to lend to companies with a long track record of profitability and over ‚Ç¨100 million in revenues, they are definitely lending less to SMEs or companies without a strong performance history.
From mid 2012 to December 2013 bank lending dipped by over 30% with most of the reduction taking place in the SME sector. Further, banks are unlikely to grow lending in the foreseeable future as Basel III will require EU banks either to raise approximately ‚Ç¨500 billion of fresh capital or to reduce lending by a further 15-20%.
The strong growth in the number of private debt funds being raised in Europe to fill the debt funding gap corresponds to a significant increase in LP allocations to the growing private debt asset class.
For LPs the private debt asset class consists of a series of private debt strategies across the risk-return spectrum ranging from senior debt across growth debt, unitranche and mezzanine to distressed debt. LPs and their advisors are increasingly setting up allocations for private debt strategies and many LPs are shifting fixed income, high yield and even private equity allocations to private debt. Private debt funds, depending on strategy and the level of risk, generate net returns ranging from mid-to-high single digits to the low-to-mid teens, and LPs are increasingly seeking out the best combinations of risk-return profiles to allocate to, or are building private debt portfolios with a mix of different risk return profiles. LPs investing in private debt expect current yield and a moderate J-curve as well as a healthy risk-adjusted return.
LPs generally prefer private debt managers who have built or are building a franchise in their space and whose track record shows that their model works through several cycles. Given the recent development of the asset class, there is recognition that many of the GPs in the space are relatively new, having spun out of larger funds, so LPs are giving some allowances regarding a ‚Äúworking together‚Äù track record given that dynamic.
A number of sessions throughout the day highlighted different aspects of private debt. The common theme throughout the day was that private debt offers a competitive advantage compared to banks, as unlike banks, private debt funds can provide customised solutions to sponsored or unsponsored deals in a short time frame with certainty of execution. Private debt funds also can offer more flexibility and customisation of covenants and repayment methods. Additionally, private debt funds often have a less rigid view of leverage capacity and more capacity to give value to non-traditional collateral. The ability to source deals locally and carry-out in-depth investment analysis were the most often cited success criteria for private debt funds.
It was clear from the Summit that the current private debt environment is seen by LPs and GPs as robust and is expected to continue to be so. A recent survey commissioned by Coller Capital found that 50% of the 140 LPs contacted had or were considering investing in private debt funds. Having taken quite a number of years for LPs to awaken to the attractiveness of the private debt asset class, it is highly likely that the LP community will continue to increase allocations to the space for the foreseeable future.