The Economist (2022-02-26) Riva

The Economist February 26th 2022 SpecialreportPrivatemarkets 9

Private credit

Sons of Drexel

A

s he ascendedthe hierarchy of corporatefinanceinthe1980s
to become king of junk bonds, MichaelMilkenstoodout.Not
least physically: he paced the trading floorofDrexelBurnham
Lambert sporting a lush but ill-fitting wig.Morethan 30 yearson,
junk bonds are a recognised part of the marketforraisingcapital.
So are other innovations spawned by the buy-outbarons,suchas
collateralised loan obligations (clos), securitiesintowhichlever-
aged loans are packaged. Fast gaining groundonthesedebtmar-
kets is one for private credit, which may nowbecausingmoreex-
citement than any other private market.
Before the financial crisis, private creditwasanichepursuit,
consisting of distressed debt and “mezzanine”finance(arisky
segment between debt and equity). Overthepastdecadeithas
spread to activities ranging from aircraft leasingto“directlend-
ing”, or loans to small and mid-size companieswithoutusinga
bank or securities firm. pefirms are cuttingoutbanksandborrow-
ing from direct lenders, including each other’screditarms,to
fund buy-outs. Banks huff at this looseningoftheirgriponfinanc-
ing pedeals that used to be backed by theirloansorjunkbonds.
The private-credit market has more thandoubledinsizesince
2015 and is now worth at least $1trn worldwide,notfaroffthe
$1.3trn institutional loan market, says Moody’s.Thebisreckonsit
may be closer to $1.5trn. Private credit hasattimesrecentlyex-
ceeded junk-bond issuance, itself at recordlevels.Transactionsiz-
es have risen commensurately. “Fifteen yearsagothebiggestdeals
were a few hundred million dollars. Now they’refourorfivebil-
lion,” says Michael Arougheti, boss of AresManagement.
Ares is one of several firms dominatingthemarket.Othersin-
clude Apollo, Blackstone and Brookfield.Aressoughttoraisea
$4.5bn credit fund last year. So strong was demandthatitclosedat
$8bn. Debt specialists are among the privatemarkets’hottestas-
sets. Brookfield bagged one of the most sought-afterin2019,pay-
ing $4.7bn for a majority stake in OaktreeCapital.Mainstream
fund managers are also gaining a foothold:creditaccountsfor
around half of BlackRock’s $320bn alternativesbusiness.
The market has been propelled by two bigforces.Oneisthere-
treat of banks, leaving a void for non-
banks. This began in the 2000s as banks
looked to trim inventory and go back to be-
ing agents, not principals. It accelerated
after the financial crisis as banks were
forced by tougher capital requirements to
offload risky assets. The second is the ubiq-
uitous search for yield. Private credit offers
juicier returns than mainstream fixed in-
come. Rock-bottom rates have “pushed ev-
er more investors into a liquidity-for-yield
exchange”, says Jean-Marc Chapus, the co-
founder of Crescent Capital.
In America, banks’ share of lending to
small and mid-size firms has fallen from
around 30% to 20% since 2010, reckons
Moody’s. Banks have also backed off prop-
erty lending, particularly for construction
and refurbishment, for which regulated

lendershavebeenhitwithsteepcapitalcharges.Spurredbyac-

countingchanges,banksacrossEuropehavemarkeddowndud

propertyloans.Private-debtfundsaresnappingtheseupat50-60

centsontheeuro,rewritingloancovenantsand,wherenecessary,

offeringborrowersfreshliquidity,saysStuartFiertzofCheyne

Capital,analternativeassetmanager.

Theyhavealsobeenbusyinmarketsthatemergedfromthe

wreckageofthesecuritisationmeltdownof2008,conjuringdeals

forspeciality-financecompaniesinequipmentleasing,consumer

lendingandreceivablesfinancing.Apollohasboughttwocar-

leasingfirms,aproviderofhome-improvementloansandacom-

mercial-mortgagelenderwithaclean-energyfocus.

Privatecreditgivesinvestorsmoreoptionsinthemiddle

groundofrisk,betweenstaidbondsorsyndicateddebtandracy

privateorgrowthequity.Expectedannualreturnsrangefrom4%

tothelowteens,dependingontheproduct.Bothfeesandtherisk

ofaninvestmentfloppingarelowerthanwithbuy-outs.Investors

withexplicitreturntargets,suchaspensionfunds,areunder-

standablytemptedbycouponsof8-10%ormore.ScottKleinman,

co-presidentofApollo,sayssuchlong-

termcapitalisagoodfitforprivatecredit.

“Itellthemthey’rethelong-termlenders

ofthefuture.”

Forborrowers,theattractionisavail-

ability:smallercompaniescan’teasilyac-

cesspublicorsyndicateddebtmarkets.

Othersvaluenegotiatingcontractsmore

closelytailoredtotheirneedsthanispos-

sibleinothermarkets,orthefactthatdi-

rectlenderscanmovequicklyandalsobe

moreforgivingofdefaults.Someborrow-

ersusethemarkettoavoiddisclosurere-

quiredinpublicdebtmarkets.Forcredit

funds,anattractionisthepromiseofex-

cessreturnforilliquidityor,asMarcRow-

an,Apollo’sboss,putsit,“complexityand

origination”.Atabigenoughscale,making

aspreadofasinglepercentagepointover

Asset managers rush in where banks feartotread,
transforming a formerly niche market

Creditable performance

United States, private credit

Source:BankforInternationalSettlements

50

40

30

20

10

0

2015102005

As%ofannual

leveragedloans

200

150

100

50

0

2015102005

As % of annual high-

yield corporate bonds