Private Markets Outlook 2021
Lending with an ownership mentality
The COVID-19 sell-off represented the sharpest market correction in history, and the impact reverberated through the debt markets as much as it did the equity markets. The role of rating agencies as the pandemic gripped the world was instrumental to the flow of debt capital. The rating agencies, disparaged during the GFC for their slow response to a changing market, were much faster this time. Rating downgrades have more than doubled during the last twelve months, leading to a growing single-B universe in leveraged loans. Loans for large-cap corporations that would have traditionally sought financing in the primary market struggled to syndicate and often found solutions in the private debt market, albeit at lower volumes, due to speed and certainty.
This trend created opportunities for us, as we were equipped to understand the nuances around ratings and the relative value that comes from offering private financing solutions to strong businesses. While the flow of capital around financial markets will continue to be disjointed in an environment coming to terms with COVID-19, rebounding private equity investment volumes strengthen our belief that we will continue to see demand for private debt.
The private direct debt market has grown to USD 848 billion and will be an integral source of financing for middle and upper mid-market companies as other sources of financing decline due to withdrawals, redemptions and a potential rise in the number of non-performing loans.
When we look at the current market, we see relative value in large and mid-cap direct senior secured loans, especially "club-style" financings, where the limited number of lenders in a debt tranche increases negotiation power. We focus on category leaders in non-cyclical, COVID-19 resilient, established businesses with stable cash flows and attractive profitability and provide them with new or incremental financing.
Despite some rebound in credit metrics, which followed the significant financial support infused into financial markets, we still see investment opportunities with better credit documentation and lower absolute leverage than we did prior to the outbreak. Leverage levels for US buyout transactions have decreased to 5.4x compared to 5.8 to 6.0x in previous years, while equity cushions in the US and Europe have increased to around 50% .
During the COVID-19 induced market sell-off in March 2020, collateralized loan obligation (CLO) issuance and primary loan issuance all but shut down due to the market’s inability to price assets. The loan market, which pre-COVID-19 was prone to downgrades and increasingly dominated by B and B- rated companies, suffered aggressive rating agency downgrades as they sought to avoid criticism for being slow to act, which they received during the GFC.
The large single B and increasing CCC universe will likely persist for some time, and will likely pressure existing CLOs, forcing them to reject lower single B rated risk and making banks reluctant to underwrite such risk. We expect this market gap to be increasingly filled by private debt providers who can provide execution certainty in return for better economics and structures.