Explosive growth of US private debt market brings parallels to ‘wild west’
There is no clear definition for so-called private debt, which is often also called direct lending or mid-market lending. It broadly consists of bespoke loans made by specialised lenders such as fund managers, insurers and tax-advantaged vehicles known as “business development companies.”
Borrowers can range from sizeable international groups to small companies seeking money for a new store — or just a shot of cash to keep trading for another quarter. Unlike leveraged loans, private debt is typically not widely traded, and unlike bonds, the market is largely unregulated and opaque.
The US market has swelled from about $300bn in 2010 to about $700bn by the end of last year, according to Bank of America, as pension funds, insurers and even sovereign wealth funds have sprayed money at the asset class. Last year fundraising topped $100bn for the fourth consecutive year, according to Preqin.
Demand has two main drivers: the falling returns on offer from more mainstream parts of the debt market, and the desire to diversify into new asset classes that are — in theory, at least — less correlated to the undulations of stocks and bonds. Institutional investors in private debt are in practice trading liquidity — the ability to move in and out of positions — for the prospect of juicier returns.
Private debt investors admit that the flood of money has dramatically eroded both standards and returns. KKR estimates that the average private debt yield has now fallen to about 6-8 per cent, down from the low teens a few years ago. That is only slightly higher than in the mainstream junk bond market, which is actively traded and far more transparent.
Even inside the industry there are concerns. Some say falling rates have spurred investors to borrow some of the money they deposit with private debt funds, in an attempt the juice the returns. One private debt fund executive, speaking on condition of anonymity, even sees similarities with the pre-crisis subprime mortgage market.
While private debt does not typically have the low “teaser” rates and brutal re-setting that proved so damaging, many borrowers might never be able to repay lenders at the end of a loan. That means the market is dependent on a constant influx of fresh money to allow borrowers to refinance, he says.
“There are a lot of parallels with the subprime crisis,” he concedes. “As long as [companies] can keep refinancing things are fine. But if there are redemptions then it means some people won’t get a seat on the musical chair. Someone will be crying.”
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