• Gerd Hübner

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068 Private Debt 304072

Private Debt. Since the financial crisis, banks have been increasingly withdrawing from lending to companies. But of course they will also need financial resources in the future. The solution to the problem is Private Debt - corporate financing through a loan from private investors. This can be very lucrative for investors. This is because private debt has attractive interest rates and attractive conditions.

"The fact that the banks withdrew from the lending business after the financial crisis has already left a noticeable financing gap in many companies," reports Valentin Bohländer of the Family Office HQ Trust. If you want to finance takeovers or future growth, have to stem investments or refinance existing debts, you need a new source of capital," the expert explains, "you will find it increasingly under the Private Debt label.

Private Debt describes the direct lending of private investors to companies. They act as lenders and provide the companies with the necessary funds. There is no intermediary in between. Der financier negotiates the conditions directly with the borrower. This form of financing is widespread in the USA. "There, companies have always financed only a quarter of their capital requirements via bank loans, while three quarters have been financed via the capital market or direct private loans," says Bohländers colleague Jan Hoffmann, a private equity and private debt analyst at HQ Trust.

In Europe, however, this is a new trend. This is where going to the house bank has a long tradition. In the past, more than 60 percent of financing was provided by banks. However, this has changed since the financial crisis - triggered by stricter regulatory requirements. The Basel III banking regulation, for example, imposes stricter requirements on capital adequacy. "This has simply made lending to companies more expensive for banks," says Hoffmann.

If banks grant fewer loans, small and medium-sized companies in particular are affected, for whom a bond issue on the capital market is too complicated or too expensive. "They are also ideal candidates for Private Debt because the instrument can be tailored," explains Gabriella Kindert, Head of Alternative Credit at NN Investment Partners: "Borrowers and lenders can negotiate the terms and conditions bilaterally according to their individual needs.

It is therefore not surprising that direct lending by institutional and private investors has been booming since the financial crisis. According to NN Investment Partners, the number of such direct transactions in Europe was only 24 in the fourth quarter of 2012, compared with around 70 per quarter last year.

The volume is also increasing strongly. According to Preqin, an alternative investment data provider, private debt funds in the US and Europe still managed around $200 billion at the end of 2007. By the end of 2016, this sum had almost tripled to almost 600 billion dollars.

Private Debt is apparently experiencing a real boom at the moment. Because not only on the part of the companies, but also among investors the interest is large. "Our clients", explains Tom Collier, private debt expert at Pimco, "are urgently looking for investments with an attractive risk-return ratio. Sie should be less risky than equities, but more profitable than bonds."

Private Debt can do that. "Overall", Jan Hoffmann informs, "investors can expect returns of three percent to double figures, depending on the risk".

"Bei Anleihen, the complexity of the credit structure, the liquidity of the security, the risk factors creditworthiness and maturity as well as supply and demand are decisive," explains Gabriella Kindert. "Investors at im Vergleich have a particular disadvantage over listed securities when it comes to the liquidity factor. Dazu, of course, it comes as no surprise that loans are also more complex. For both, investors will be compensated with higher returns."

Unlike bonds, private securities cannot simply be sold via the market. "We must therefore be prepared to hold this loan for the entire term of five to seven years," says Tom Collier. The higher complexity of private debt is due to the fact that the credit structure and the costly documentation of the conditions are individually negotiated and it is sometimes difficult to bring buyers and sellers together. "In return, Private Debt offers an additional yield premium," explains Kindert.

For investors it is not only interesting from the point of view of returns to invest part of the assets earmarked for interest rate investments in private debt. "We have noticed that the correlation to the traditional, listed asset classes is often low because completely different debtors play an important role here," explains Kindert. "The fixed income portion can be better diversified, the total portfolio better balanced."

In addition, there is another advantage: private debt is usually subject to variable interest rates. Usually a surcharge on the three-month money market rate is paid in US dollars. If this rate rises because, for example, the US Federal Reserve raises its key interest rates, the interest coupon climbs with it. "Unlike securities with fixed coupons, there is no need for price losses. Investors therefore take a low interest rate risk," Collier explains.

In the meantime, however, Private Debt has become a little victim of its own success. The fact that more and more capital is flowing into this area weakens the lenders' negotiating position. According to Preqin estimates, private debt funds already had around 224 billion dollars of unused liquid funds at their disposal in the middle of last year. Experts refer to this as dry powder. "These are funds that want to be invested and which naturally compete hard for the most attractive investments," Hoffmann makes clear. In other words: Investors are currently scrambling for good deals.

As a result, good debtors who are particularly attractive to investors are in a comfortable negotiating position. Not only can they enforce their ideas regarding the respective credit clauses, but they also get the credit cheaper than in the past. "In fact, the yields on simple loans to good borrowers have fallen sharply in recent years in parallel with the risk premiums on corporate bonds," notes Tom Collier. "But we still see potential in sectors where credit supply is lower and complex credit."

Overall, however, this means that investors wishing to achieve high returns now have to take greater risks in this segment as well. "There are different rankings for these investments," Hoffmann explains. "First, senior secured debt. They are comparatively safe, but the returns are usually only around three percent." Subordinated securities, i.e. the so-called junior debt or subordinated debt, bring more. "Yields in the low double-digit range are still possible there. But of course the risk is correspondingly higher."

However, most private investors, NN Investment Partners has observed, do not position themselves either in the particularly safe but unprofitable area or in the very riskanten Segment. So-called unitranches, which mix senior and junior debt, are used most frequently. Their yield is around 600 basis points above that of comparable bonds.

"This illustrates what a fascinating and broad spectrum of investment opportunities this market offers", Valentin Bohländer reflects and concludes: "For investors this has advantages and disadvantages. On the one hand, they can find investments that exactly match their individual risk-return profile. On the other hand, they will only be able to work there if they have very large resources and excellent analytical capabilities."

Therefore, the detour via closed private debt funds is usually the right alternative. Recently, a number of such vehicles came onto the market. Some even specialise in the European market and do not expose their investors to currency risks.

Those who have already ventured the private debt adventure are apparently very satisfied. 95 percent of the institutional investors surveyed by Preqin state that their return expectations have been met or exceeded. As many as 62 percent therefore want to increase their weighting in this area in the long term. They see direct lending as an interesting alternative to the bond market.


How to invest in Private Debt.

"Due to the longer history and the breadth of the market, the US market is basically the most attractive," explains Valentin Bohländer of the Family Office HQ Trust, "but currency risks and tax reasons are good arguments for a stronger focus on the European market.

A lot has happened there in recent years. According to NN Investment Partners, European direct lending funds with a total volume of 50 billion dollars have been launched since 2013. This corresponds to around 43 per cent of all direct loans granted worldwide during this period.

The great art for investors is to select the offers. "If you want to invest, you can't avoid taking a very close look at the management of such a fund," advises Bohländer. How good are the credit analysis skills for potential borrowers? "This is important because a temporary exit from Private Debt is not possible. Es it must therefore be ensured that the debtor is able to service the loan over the entire term and also repay it at the end of the term."

This requires experience and know-how. Especially in the less transparent area of small and medium-sized companies that are not active on the capital market, it is difficult to find attractive borrowers and assess whether the risk-return profile is advantageous, and then also to negotiate the contract terms that are suitable for the investor. "The manager should be able to prove a longer track record and have already proven his abilities in this area," says Bohländer. And there's something else to note. "Don't chase after höchsten Renditen," the expert advises, "in recent years this market segment has also performed very well. If another financial accident should happen anywhere at any time, it is good if the fund manager has not taken too high a risk."

It is difficult to make this selection yourself. Interested investors must therefore rely on the judgement of their asset managers or financial advisors.

Another hurdle: These vehicles are usually launched as closed-end funds. Investors can therefore only subscribe if the fund is launched and should - in addition to the management - also scrutinise costs, fees and profit-sharing. For more information:

// Permira Debt Managers


// Pemberton (www.pembertonam.com)

// Muzinich & Co. (www.muzinich.com)

// Rothschild (www.rothschild.com/en/merchant-banking/direct-lending)

// Ardian (www.ardian.com/activities-team/private-debt)

// Patrimonium (www.patrimonium.ch)

// BlueBay (www.bluebay.com/en/strategies/investments/private-debt)



Author: Gerd Hübner

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