Steven, one of the things few could have predicted back in 2009 was the growth of private debt funds. You’ve recently published a paper on these. What is the key takeaway and what comes next for this part of the private markets sphere?
“One of the more significant findings to come out of the private debt survey is that this is an example of where regulation has worked as it was intended. After the GFC, Dodd-Frank legislation in the US was an attempt to remove risk from commercial banks because they are highly levered. The credit funds are only levered at about 50%, versus banks at around 80-90%.
“The big question now is whether the private debt funds can continue to generate the returns that their investors expect. Returns have been strong so far, with loans priced at around 600-700 basis points over LIBOR. This is fine when there are few or no defaults. But what will they be like in a recession if defaults start to ramp up? One positive is that there is evidence to suggest that PE firms are likely to support distressed companies with equity injections – there is a higher equity cushion today than previously and so they are incentivised to do so. There are also relationships between sponsors and the debt funds, so restructurings should be easier than with the banks.
“I think we also need to watch for whether some funds have done too much. Some have been buying insurance companies or some insurance companies have been buying them. That may not cause systemic risk because contagion of the type we saw in the GFC is less likely, but we should keep an eye on this.”
Steven Kaplan
“I’d tend to agree. The performance of private debt funds has been great so far, but we’ve seen a lot of financial products in the past that worked well – until they didn’t. If we go into an era of interest rates that are higher for longer and recessionary risk increases, what will be the consequences for private debt fund portfolio companies? We don’t yet know the answer.”
Josh Lerner