Private Debt Investor: Disciplined managers set to enjoy spell in the sun

Rising default rates, falling M&A activity and renewed competition from the syndicated loan market could be interpreted as bad omens for the private credit industry. But that’s not the whole picture, says Robin Doumar, Founder and Managing Partner at Park Square Capital.

Doumar agrees that there will be more discrepancies in how managers perform; yet he believes that private credit continues to benefit from powerful tailwinds – higher yielding strategies, he points out, can almost match private equity returns, with considerably lower risk.

The key to success, Doumar tells PDI, is to remain disciplined in lending only to high-quality businesses.

With the syndicated loan market showing signs of life, how will private credit perform over the next year?

For high-quality transactions, the market has reopened on both sides of the Atlantic after a year-and-a-half hiatus. To some degree, business will return to the syndicated loan market, especially for larger tranche loans.

Having said that, I do think that many of the inroads that private lenders have made into the syndicated loan market are likely to be sustained. Private debt firms will emerge with a significantly larger share of the lending business than they’ve historically held.

While we certainly like being in a lenders’ market, where we’ve had improvements in term structure and pricing, we don’t want financing to be so expensive that it restricts transaction activity; that’s been the world we’ve been living in for the past 18 months.

We were at a ten-year-low in terms of M&A transaction activity in the first quarter of 2023. The big benefit of the syndicated loan market’s reopening is that we’ll see more deal activity, and that’s also fantastic news for firms providing solutions in junior debt. And I don’t think it’s bad for the existing middle market direct lending business either; mid-market companies will continue to use middle-market direct loans, and in the large-cap space, private debt firms have made gains relative to the CLO market.

Are you optimistic about the outlook for the industry as you were a year ago?

Yes, I think it’s a terrific market. A year ago, we were facing a substantial dislocation in both the debt and equity markets, and so we deployed significant capital into the secondary market, acquiring loans at a discount. And that has been terrific. But at some point, we needed to see new deal activity resume, because that’s the bigger component of our business.

[Therefore] it’s encouraging for me to see the syndicated loan market reopening for high-quality borrowers and it’s a very promising time for the industry; base rates are up, leverage levels are lower than they were 18 months ago, and it’s clear that the trend is pointing towards a substantial increase in transaction activity.

As buyers of loans have started to ramp up investment activity, the inventory that was for sale in the secondary loan market has now been cleaned out. Demand for loans has caught up, and the greater transaction volumes will likely soak up some of that demand.

What will be the key factors that will determine how managers perform?

Two critical things have happened. Firstly, after we went through the global financial crisis, it became clear that we needed to be very careful about banks making risky bets with depositors’ money. The regulation and the retreat of banks from the lending space created a big market opportunity for private credit.

Secondly, very low interest rates pushed institutional investors, in their search for yield, to look for alternatives to traditional credit and fixed income.

What really changed things was the movement of pension funds and institutional investors into alternative credit as a standalone asset class. Private equity allocations, historically, were quite small; credit managers were raising money from that small alternative allocation.

But big, sophisticated institutional investors – pension funds, insurance companies, and others – created separate buckets in the form of fixed income alternatives, including for private credit. That has had an enormous impact, because when you start taking sizable percentages of entire pension fund allocations, it translates into a massive amount of capital available for the market.

October 2023