Financial Times Europe 02Mar2020

6 | FTfm † FINANCIAL TIMES Monday 2 March 2020

T H E B I G P I C T U R E

P

rivate debt has become

one of the hot topics for

fund managers desperate

to build a fee-rich asset

class at a time when their

traditional businesses are struggling.

But even industry insiders are now

warning that the boom in private

debt is turning into a frenzy.

Once a niche area of the global asset

management industry, assets

invested in private debt — largely

made up of non-bank loans to

unlisted companies — reached a

record $812bn in 2019, putting the

market on track to break through the

$1tn barrier within the next year.

The number of asset managers

operating in the field also reached a

new high last year, totalling 1,764,

more than double the amount five

years earlier, according to consul-

tancy Preqin.

The main managers competing for

assets were historically US private

equity groups with credit arms, such

as KKR and Blackstone. But more

mainstream fund groups, including

M&G, Schroders, Amundi and Stand-

ard Life Aberdeen, have made forays

into the market in recent years, eager

to take advantage of healthy investor

appetite.

Private debt is moving into the

mainstream as investors hunt for

higher yield. Its growth has been

spurred by banks quitting the market

when they rationalised their loan

books to meet tougher capital rules.

“Sovereign wealth funds and large

state pensions were among the earli-

est adopters, but increasingly the rest

of the institutional investor world has

followed suit,” says Ji-Eun Kim, head

of private asset manager solutions at

Schroders.

“Private debt’s... enhanced cash

yields are especially attractive in a

low-return environment.”

However, a growing chorus of sen-

ior figures are voicing fears that the

market is looking frothy as too much

capital chases too few deals.

“It would be crazy to start a private

debt business right now,” says a

former senior private debt executive.

Another senior private capital fund

manager thinks the asset class is in

bubble territory. “We see the same

movie happen every time. When too

much money goes into one place the

outcome isn’t great.”

Vulnerabilities are being exposed.

In February, Hadrian’s Wall Secured

Investments, a listed fund that lent

money to UK small and medium-

sized companies, said it was winding

down its business after warning of

“material” losses on investments in

two biomass companies.

Preqin data show that over the past

four years 327 direct lending funds,

the most common type of private

credit strategy, have been raised, with

about $207bn flowing into the strate-

gies.

At the same time, dry powder, the

amount raised for direct lending but

not invested, is at a record $112bn.

Dry powder for all private credit,

including strategies such as dis-

tressed and mezzanine debt in addi-

tion to direct lending, stands at

$261bn, a figure which is down

slightly on the year before but still

represents the second-highest level

on record.

The capital raising frenzy, com-

bined with competition among lend-

ers, is damaging returns and loan

condition standards are suffering.

Jaime Prieto of Kartesia, an asset

manager that lends to SMEs, says that

some managers are yielding to pres-

sures by agreeing to weaker loan

terms and looser covenants.

“The huge amount of capital float-

ing around means that it is inevitable

there will be some deterioration in

credit quality,” says the former senior

executive. He says mounting lever-

age across private assets is evidence

that problems are building up as they

did in the run-up to the subprime

mortgage market crisis.

Mariano Belinky, chief executive of

Santander Asset Management, which

set up a private debt unit last year,

says that more problems are coming

down the track. He highlights the

spate of bumper fund launches as an

area of concern. Last year a private

debt fund managed by BlueBay Asset

Management raised €6bn, while a

vehicle from BNY Mellon subsidiary

Alcentra closed at €5.5bn, nearly

double its minimum target.

“How do you deploy that capital at

scale?” he asks. “As the asset class

keeps heating up, a lot of these man-

agers will have a tougher time finding

good deals.”

Other industry executives warn

that the cracks now on show will

become much wider when the mar-

ket cycle turns.

Nicholas Brooks, head of invest-

ment research at Intermediate Capi-

tal Group, the £42.6bn specialist

credit manager, says rising markets

over the past decade have masked

problems lurking under the surface.

“There are probably a number of

newer players that are lending

unwisely but we won’t know until we

get to the next downturn.”

There are also concerns that some

fund groups have jumped on the pri-

vate debt bandwagon without the

skills to fully understand the risks of

the loans they provide.

“As managers raise bigger funds,

the question becomes can they origi-

nate big enough loans and do they

have teams of experienced people to

sort things out when problems arise,”

says Paul Shea, co-founder of special-

ist SME loan manager Beechbrook.

Senior figures

warn market

looks frothy with

too much capital

chasing too few

deals, write

Siobhan Riding

and Robin

Wigglesworth

Private debt frenzy reaches $800bn

$112bn

Direct lending

funds’ level of dry

powder, the

amount raised

but not invested

€6bn

Amount raised

last year by a

private debt

fund managed

by BlueBay

FINANCIAL TIMES Monday 2 March 2020 † FTfm | 7

T H E B I G P I C T U R E

Mr Belinky says Santander AM’s

private debt unit, which benefits

from access to its parent bank’s origi-

nation pipeline, has been approached

by groups that are struggling to find

deals by themselves.

“Managers have come in and said

‘Hey, we’ll buy 50 per cent of what-

ever you originate’. That gives you a

sense of how managers have limited

access to good deals.”

But Ken Kencel, chief executive of

Churchill Asset Management, which

examined 800 potential deals last

year, takes a different view, arguing

ample opportunities abound.

He says credit quality is holding up,

particularly at the upper end of the

market where fewer managers com-

pete. Competition has been acute

among those looking to arrange loans

for small and midsized companies.

Mr Kencel says that the groups that

are able to write bigger cheques to

corporates are still in a minority and

will flourish in the coming years.

But writing big cheques is also

risky, making it even more important

for fund managers to have large

teams of professionals tasked with

monitoring the loans they have made.

Established private debt managers

that benefit from revenue streams

from existing funds can afford to

finance this. But newcomers may

take years before they turn a profit

considering the high costs of arrang-

ing private loans and the fact that

many groups earn management fees

Plenty of dry powder in the market

bn

Source: Preqin















         

All private debt

Direct lending

‘As the asset

class keeps

heating up, a

lot of these

managers will

have a tougher

time finding

good deals’

Private debt funds raise record sums

Aggregate capital raised by private debt funds (bn)

Source: Preqin

















     

North America-focused

Europe-focused

Asia and rest of world-focused

    

based on the amount of money they

have invested, rather than raised.

Many believe the market is set for a

wave of consolidation in which

smaller and less specialist groups will

be squeezed out or merge with com-

petitors. Investors are increasingly

gravitating towards more established

managers with larger funds; accord-

ing to Preqin, the 10 biggest funds

that closed last year accounted for

36 per cent of new capital raised.

Mr Belinky says that some manag-

ers are already conceding defeat.

When his company was recruiting for

a new private debt team last year, it

received applications from profes-

sionals whose previous employer had

been forced to close their private debt

funds because they failed to find

enough companies to lend to. “When

we interviewed them, they said they

had commitments from investors

and were ready to go but just couldn’t

find enough assets to put the capital

to work,” he says.

In January, Swedish private equity

firm EQT said it was considering

offloading its €3.9bn credit arm to

focus on its core business. M&A activ-

ity is already under way among spe-

cialist direct lending entities in the US

known as business development

companies or BDCs. Crescent Capital

last year acquired Alcentra’s BDC,

taking its portfolio to $923m.

“In a more challenged credit envi-

ronment, some of the smaller shops

are going to find it hard to service

their portfolio and have the resources

needed to deal with restructuring

their portfolios,” says Mr Kencel.

“Rather than spending significant

time working through these prob-

lems, some are likely to opt to sell.”