The riskiest corners of corporate debt markets have escaped the widespread damage of the Covid-19 economic crisis. Some fund managers believe that a math can still be done in the rapidly growing world of private small business lending.
Private debt has become an important part of the financial infrastructure in the United States and Europe since the 2008 financial crisis, as banks cut their lending to small businesses. It differs from other forms of loan because it is made directly from a specialized fund manager to all kinds of companies – dentists, restaurateurs, insurance brokers and software publishers, among others – without going through a bank or bond markets.
Many businesses have had a hard time during shutdowns, but unprecedented support from governments and central banks in the US and European economies limited the damage.
“Next year, when the [government] the funding stops and companies have to pay that money back, that’s when the problems will arise, ”said Ganesh Rajendra, managing partner at Integer Advisers, a London-based consultancy firm.
Assets under management of private debt funds grew from less than $ 200 billion globally in 2007 to $ 850 billion at the end of March of this year, according to the latest data available from Preqin, a research firm. Fundraising has slowed this year, but the funds still have nearly $ 300 billion in uninvested capital.
There have been failures in the private lending market, such as UK department store chain Debenhams, a mid-sized company that ended up owned by its private lenders before going into liquidation.
The U.S. private credit default rate reached 8.1% in the second quarter, compared to nearly 6% in the first quarter, according to an index created by the US law firm Proskauer Rose LLP. In the third quarter, the rate fell to just 4.2%.
By comparison, in May, when the Covid-19 crisis was in its first wave, rating agency Moody’s forecast default rates of at least 11% and up to 21% among badly rated borrowers. worldwide in 2020. These forecasts have since been revised downwards. .
“People tend to predict things early: just because the faults haven’t happened yet, it doesn’t mean they won’t. Said Andrew McCullagh, Managing Director of Hayfin Capital Management, one of Europe’s largest private lenders with around $ 20 billion in assets.
“When you arrive in June of next year and a company comes back for the next round [of extra funding or covenant relief], by then you will have 15 months of poor performance and you will have to ask yourself if this is a company that is going to come back, ”he said.
It is difficult to assess the performance of private debt funds because, like private equity funds, they lock in investor money and their actual performance may not be apparent for five years or more.
Many funds do not have to adjust the valuation of their loan portfolios aggressively while debt service is still in progress. This differs from banks, which must take into account economic conditions and the likelihood of companies developing repayment problems.
Chris Skinner, head of UK debt and equity advice at Deloitte, said this year it was very difficult for lenders to judge the performance of long-term borrowers as the Covid-19 crisis continues to decline. ‘bring a lot of uncertainty to economies. This made them reluctant to reduce the value of the loans if they did not have to. “People have pleaded fifth on the ratings,” he said.
Private lenders have given borrowers more leeway this year so they don’t default. One window to what happened is through business development companies, the publicly traded versions of private lenders.
A business development company led by
Arès management Corp.
, one of the world’s largest private credit managers with more than $ 130 billion in assets in its debt business, told investors in August it had amended covenants on 40 different loans over the past year. only second trimester. Other BDCs, including those managed by
Black rock Inc.
reported changes from a similar proportion of their borrowers.
BDCs suffered price drops of more than 50% in March and April, but have since reclaimed much of that land.
Blair Jacobson, co-head of European credit for Ares, said many of his coronavirus-hit borrowers in his private credit funds were resilient businesses such as dentists or veterinary practices. “The rebound has been strong: many of these companies that needed postponements have already managed to get them,” he said.
Another factor that maintains the creditworthiness of borrowers is that many of them are backed by private equity funds, which are less indebted than in the past. There is more equity in most businesses and loans account for around 50% of the company’s value, Jacobson said, up from 70 to 80% before the last financial crisis.
“Private equity owners have a lot more to do and a lot more to go wrong before lenders suffer losses,” he said.
Write to Paul J. Davies at [email protected]
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