Private credit, once one of the safer alternative investments available to longer term investors, is losing its sheen. With large sums of money flooding the sector, the lending standards have been relaxed and leverage has increased. Industry insiders say that borrowers, generally private equity firms, take the advantage of numerous options now available to support investments. Private credit managers now have about $600 million to be given away.
Lenders and risks
Things have changed now. A loan even a few years ago would be calculated on the percentage of the portfolio company's earnings. Lenders nowadays grant bigger quantum of loans to borrowers. These are being done in the expectation that developments in the future will boost the earning of the company included in the portfolio. This change of stance has made investments done in private credit and private equity much riskier. This will skew all private credit benchmarks. Returns will also be distorted. Investor apprehensions are succinctly put by Tom Cawkwell of Albourne America LLC. He voiced doubts about the capital flood now sloshing in this finance universe. He said that the real risk is present in the quantity of leverage inherent in these transactions. He added that lenders will inject in the anticipated synergies that the portfolio company may achieve in future. These will only increase the earnings. He said that the risk factor is slowly building and it will continue to do so until it gets managed by the finance industry.
As per Preqin, the London headquartered alternative research firm, limited partners are now investing in a few private credit strategies. They are doing this so that they can continue to hunt for yield. About 32 percent of the investors have seen a minimum six percent of total assets allocation to private debt. About 17 percent of the investors have targeted between six percent and 10 percent. The report was co-authored by NXT Capital LLC, the Chicago credit manager.
Preqin also reported that a total of $605.5 billion worth of assets are controlled by private debt managers globally. The amount is a blend of 'not invested' money and invested assets' unrealized value. This number was valid up until December 31. The number is an increase of 10 percent or approximately $54 billion from December 31, 2015. The amount of money does not end here. Managers are all set to add a bigger chunk of capital to their existing coffers. Private debt funds, about 284 of them, is trying to collect a total of $112 billion.