Welcome to Financing the Economy 2018, the fourth edition in a series of papers analysing the global private credit industry produced by the Alternative Credit Council (ACC), the private credit affiliate of the Alternative Investment Management Association (AIMA). This edition is again produced in partnership with Dechert LLP.
We are delighted to be publishing this research at a time when policymakers are re-evaluating their approach to the non-bank lending sector. The Financial Stability Board recently announced that it will no longer use the term shadow banking in its work. We warmly welcome this move as the ACC, and this report in particular, have consistently argued that this term was an inappropriate label for distinct, legitimate, regulated and transparent business models. We hope that this research will continue to build on the successful dialogue between our industry and policy makers.
In past editions of this paper we have charted how private credit has grown from being a relatively niche industry to a fully-fledged global source of financing for mid-market corporates in particular. The sector remains on track to reach $1 trillion AUM by 2020. There are numerous data points and case studies throughout this report that demonstrate how private credit managers are supporting the economy in new ways, growing in areas like real estate finance, trade finance or asset-backed lending. It is also apparent that this growth is increasingly fuelled by allocations from institutional investors, with pension funds making up the largest group.
This is a significant vote of confidence in the sector and a sign that private credit managers have established themselves as a credible mainstream option for investors, in the same way that they have established themselves as a mainstream finance option for borrowers.
While the fundamentals driving the growth of private credit remain strong, the factors supporting that growth are facing several tests. The market remains extremely competitive with private credit managers working ever harder to compete for deal flow. This dynamic is evident in the continued pressure on deal terms, as well as the growing use of leverage in some parts of the market. Private credit managers are mindful that we are getting ever closer to the top of the credit cycle, if not the economic one.
As we look ahead to 2019, we and the industry practitioners are thinking hard about the risks that may lie ahead, not just for individual portfolios but for the sector as a whole. Our performance during a period of economic stress is likely to shape borrower, investor and policymaker attitudes towards private credit for years to come. Our ability as an industry to maintain good financial discipline and communicate not just with our immediate stakeholders but also the general public during this period will be a determining factor in ensuring a sustainable future for the asset class. This research aims at such an honest and transparent engagement on the part of managers and members of the ACC with the broader market and society at large.
Deputy CEO, Alternative Credit Council
Chairman Alternative Credit Council and President Cheyne Capital
Partner, Financial Services, Dechert LLP
Financing the whole economy: Private credit is a globally established source of mainstream finance for borrowers around the world. Managers are increasingly lending to a far wider variety of borrowers outside of the mid-market than ever before: from smaller businesses and startups, to larger corporations and infrastructure projects. Nearly a third of all capital invested (by the respondents to this survey) supports non-corporate lending strategies, including asset-backed finance, trade finance, receivables, real estate and distressed.
Borrowers can access bespoke financing that offers far greater flexibility than traditional bank lenders. One in four private credit managers surveyed provide financing to companies with EBITDAs of over $75 million and over 40% surveyed are lending to companies with EBITDAs of less than $25 million. The tangible benefit of private credit to the real economy can be seen through the multiple borrower case studies presented throughout this paper.
Working with borrowers: Private credit managers are an important source of long-term finance for borrowers. A wider selection of financing structures as well as more competitive lending terms means borrowers of private credit now have more choice than ever when looking for financing, and thus more negotiating power. Borrower fees, loan coupons and covenants are a good measure of this, and the new data in this paper on all three indicates that borrowers of private credit are in a strong position.
Delivering for investors: The investor base of private credit continues to grow. Over 70% of all private credit committed capital1 now comes from institutional investors. The diversity of private credit means that there are also attractive strategies for smaller or non-institutional investors such as family offices, which account for 5% of committed capital allocated to private credit. New findings in the paper indicate that 32% of capital committed to private credit today comes from North American investors. In new evidence that the European market is becoming a core region for private credit, 31% of industry committed capital comes from Europe (excluding the UK). Also, in Europe, insurers now account for twice the amount of committed capital when compared to North American counterparts.
Experience with lending: The majority of private credit managers that reported to this survey have long-standing experience of the sector. Nearly half of all respondents have been managing private credit for over 10 years, with experience across multiple fund vintages and loans.
Cautious optimism: Private credit managers expect continued growth across the asset class but are also preparing for the possibility of an end to the current credit cycle and tougher economic conditions for borrowers. Managers are preparing by lending at higher positions within the capital structure, and by avoiding or rotating away from cyclical sectors.
Use of financing: More than half of all managers and investors surveyed, prefer unlevered private credit strategies. Where leverage is employed by managers, it tends to be at relatively low levels although those levels have risen slightly over the past year.
Appropriate fund structures: Approximately two thirds of all managers surveyed have closed-ended commitment and drawdown fund structures. With these structures, the maturity of the capital committed to private credit strategies is matched to the finance that managers are providing to the real economy. This is a two-fold benefit for the financial system; (i) it provides a stable source of long-term capital for borrowers, and (ii) it mitigates against pro-cyclical tendencies in the credit markets and acts as a natural stabiliser.
Financing the Economy 2018 draws its content from several different sources. The backbone of this paper is provided by a survey conducted by the Alternative Credit Council (ACC) and Dechert LLP (Dechert) of private credit managers. Almost 70 private credit managers responded to the survey; collectively they manage an estimated $470 billion in private credit investments, across a broad cross-section of jurisdictions and strategies.2 The survey data was then explored by the ACC and Dechert in a series of roundtables and one-on-one interviews. Managers were also invited to submit case studies of how their firms are contributing to the real economy, which you can find throughout this paper.
Throughout this paper you will note we refer to large private credit managers and smaller private credit managers who count among the respondents that contributed to this paper. Where we describe larger managers, this refers to managers that have over $1 billion committed to private credit investments, while smaller managers are those that have under $1 billion committed to private credit investments.
• Private credit managers expect continued growth across the industry but are also preparing for the possibility of an end to the current credit cycle and tougher economic conditions for borrowers.
• Private credit managers are increasingly lending outside of the mid-market. Almost 25% of private credit managers provide financing to companies with EBITDAs of over $75 million and over 40% are lending to companies with EBITDAs of less than $25 million. This trend, first identified in last year’s Financing the Economy, looks set to continue.
• Private credit managers continue to work with borrowers to provide tailored finance solutions. As well as benefitting from a greater choice of finance products, borrowers are also seeking more flexibility on loan covenants and driving a hard bargain on pricing.
• Private credit managers continue to develop additional loan origination pathways with nonsponsored lending continuing to grow in relative importance.
Investors in Private Credit
• The investor landscape of private credit is becoming increasingly diverse, with a wide range of investor types, both institutional and otherwise, committing capital to private credit.
• The majority of capital committed to private credit comes from North America.
• There is still a significant number of investors committing capital to the industry for the first time, indicating that opportunities remain.
• Investors of all types have a choice of positions in borrowers’ capital structures to match their risk and return appetites.
• Private credit managers are flexible when it comes to working with investors: a strong majority are willing to run separately managed accounts.
Fund-level Leverage and Financing
• The majority of private credit managers do not use fund-level leverage, in keeping with trends highlighted in previous editions of this survey.
• Those managers who report they use fund-level leverage to finance their lending activity do so in a conservative manner—close to three quarters of managers using borrowing against their assets report levels of debt to equity lower than 2-to-1.
• Larger managers that use leverage tend to employ higher levels of leverage than smaller managers.
• The terms of such asset financing are generally matched to the maturity of the underlying loan portfolios.
• There are some parts of the industry that are seeing higher levels of leverage being used, as financing of loan portfolios becomes more widely available and more sought after by certain types of investors.
• The use of subscription financing—borrowing against investor commitments—has also become prevalent, with nearly three quarters of managers using such facilities for terms of up to one year.
Financing Economy 2018 - The role of private credit managers in supporting economic growth
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