The conditions that brought opportunity and growth to private debt remain in place, and continued expansion, driven by aggressive fundraising, can be expected in 2015 and beyond. In this paper, Brown Brothers Harriman and Preqin explore the systematic and secular shift to private debt investing and examine what types of asset managers are likely to succeed.
THE ERA OF BANK DISINTERMEDIATION
In the wake of the financial crisis the global economic landscape continues to reshape itself. One driver has been the measures taken to prevent bank insolvency from striking markets again. Macroeconomic factors and liquidity concerns have influenced the development of large scale regulatory directives such as Dodd-Frank, Alternative Investment Fund Managers Directive (AIFMD), and Basel III. These regulatory requirements have forced banks to off-load inventories of corporate and mid-market debt assets, and to scale back traditional lending for the foreseeable future. Banks are mandated to simplify their businesses and shrink balance sheets. In 2012, the International Monetary Fund estimated that European banks needed to reduce their asset base by $2.6 trillion1
While in the US, banks have reduced leverage to nearly single digit levels2, resulting in a decline in loan originations. Although banks are paring back lending, the demand for capital remains. The liquidity to fuel American and European businesses is now coming from alternative investments and fixed income managers who have entered the private debt market to fill the incremental lending vacuum left by bank disintermediation.
THE RISE OF ALTERNATIVE LENDING
Fund manager and specialty finance participation in primary lending activity is hardly a new phenomenon, but in light of the low yield environment, the private debt segment is enjoying a healthy growth scenario. Since 2006, the private debt industry has nearly tripled in size, with AUM increasing from $152 billion to $441 billion as of September 20143. This model has taken firm hold in the US and is on the rise in Europe.
1Global Financial Stability Report, The Quest for Lasting Stability, April 2012, page 6.
2 The Economic Times, Need to focus Central Banks’ move: Paul Schulte, Schulte Research, May 4, 2015.
3 Preqin, 2015 Preqin Global Private Debt Report, page 11. Preqin Private Debt Online.