Financing the Economy 2018 - The role of private credit managers in supporting economic growth
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Financing the
Economy 2018
The role of private credit managers
in supporting economic growth
lendingforgrowth.org
Financing the Economy 2018 © Alternative Credit Council 2018. This publication should not be considered as constituting legal advice or as a substitute for seeking legal counsel. It is provided as a general informational service and may be considered attorney advertising in some jurisdictions. To the extent permitted by law, neither Dechert LLP, nor any of its members, employees, agents, service providers or professional advisers assumes any liability or responsibility for, or owes any duty of care in respect of, any consequences of any person accessing any of the information pertaining to the case studies contained in this publication. For the avoidance of any doubt, the case studies included within this publication have been requested by the Alternative Credit Council (ACC), and collated and prepared by members of the ACC executive staff. The information contained in these case studies is for general informational purposes for readers of this publication only.
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Contents
Foreword 4
Executive Summary 5
Manager Demographics 6
Borrowers 9
Investors in Private Credit 21
Fees 27
Fund-level Leverage and Financing 34
Fund Structures 40
Conclusion 45
Case Studies 46
3
Financing the Economy 2018
Foreword
Welcome to Financing the Economy This is a significant vote of
2018, the fourth edition in a series confidence in the sector and a
of papers analysing the global sign that private credit managers
private credit industry produced by have established themselves as
the Alternative Credit Council (ACC), a credible mainstream option for
the private credit affiliate of the investors, in the same way that
Alternative Investment Management they have established themselves
Association (AIMA). This edition is as a mainstream finance option for
again produced in partnership with borrowers.
Dechert LLP. Jiří Król
While the fundamentals driving
Deputy CEO,
We are delighted to be publishing the growth of private credit remain Alternative Credit Council
this research at a time when strong, the factors supporting that
policymakers are re-evaluating growth are facing several tests.
their approach to the non-bank The market remains extremely
lending sector. The Financial competitive with private credit
Stability Board recently announced managers working ever harder
that it will no longer use the term to compete for deal flow. This
shadow banking in its work. We dynamic is evident in the continued
warmly welcome this move as the pressure on deal terms, as well as
ACC, and this report in particular, the growing use of leverage in some
have consistently argued that this parts of the market. Private credit
term was an inappropriate label for managers are mindful that we are
distinct, legitimate, regulated and getting ever closer to the top of the Chris Gardner
transparent business models. We credit cycle, if not the economic Partner, Financial Services,
hope that this research will continue one. Dechert LLP
to build on the successful dialogue
between our industry and policy As we look ahead to 2019, we
makers. and the industry practitioners are
thinking hard about the risks that
In past editions of this paper we may lie ahead, not just for individual
have charted how private credit portfolios but for the sector as a
has grown from being a relatively whole. Our performance during a
niche industry to a fully-fledged period of economic stress is likely
global source of financing for mid- to shape borrower, investor and
market corporates in particular. The policymaker attitudes towards
sector remains on track to reach private credit for years to come. Stuart Fiertz
$1 trillion AUM by 2020. There are Our ability as an industry to Chairman, Alternative
numerous data points and case maintain good financial discipline Credit Council, and President,
Cheyne Capital
studies throughout this report that and communicate not just with
demonstrate how private credit our immediate stakeholders but
managers are supporting the also the general public during this
economy in new ways, growing in period will be a determining factor
areas like real estate finance, trade in ensuring a sustainable future for
finance or asset-backed lending. It the asset class. This research aims
is also apparent that this growth is at such an honest and transparent
increasingly fuelled by allocations engagement on the part of
from institutional investors, with managers and members of the ACC
pension funds making up the with the broader market and society
largest group. at large.
4
lendingforgrowth.org
Executive Summary
Financing the whole economy: Private credit is a Europe (excluding the UK). Also, in Europe, insurers
globally established source of mainstream finance for now account for twice the amount of committed capital
borrowers around the world. Managers are increasingly when compared to North American counterparts.
lending to a far wider variety of borrowers outside
of the mid-market than ever before: from smaller Experience with lending: The majority of private
businesses and startups, to larger corporations and credit managers that reported to this survey have long-
infrastructure projects. Nearly a third of all capital standing experience of the sector. Over 60% have been
invested supports non-corporate lending strategies, operating for over six years, with experience across
including asset-backed finance, trade finance, multiple fund vintages and loans.
receivables, real estate and distressed. Borrowers
Cautious optimism: Private credit managers expect
can access bespoke financing that offers far greater
continued growth across the asset class but are also
flexibility than traditional bank lenders. One in four
preparing for the possibility of an end to the current
private credit managers surveyed provide financing to
credit cycle and tougher economic conditions for
companies with EBITDAs of over $75 million and over
borrowers. Managers are preparing by lending at
40% surveyed are lending to companies with EBITDAs
higher positions within the capital structure, and by
of less than $25 million. The tangible benefit of private
avoiding or rotating away from cyclical sectors.
credit to the real economy can be seen through the
multiple borrower case studies presented throughout Use of financing: More than half of all managers and
this paper. investors surveyed, prefer unlevered private credit
strategies. Where leverage is employed by managers, it
Working with borrowers: Private credit managers
tends to be at relatively low levels although those levels
are an important source of long-term finance for
have risen slightly over the past year. While there is a
borrowers. A wider selection of financing structures
growing investor acceptance of the use of financing for
as well as more competitive lending terms means
liquidity management, investors remain vigilant about
borrowers of private credit now have more choice
this being used for leverage purposes.
than ever when looking for financing, and thus more
negotiating power. Borrower fees, loan coupons and Appropriate fund structures: Approximately two
covenants are a good measure of this, and the new thirds of all managers surveyed have closed-ended
data in this paper on all three indicates that borrowers commitment and drawdown fund structures. With
of private credit are in a strong position. these structures, the maturity of the capital committed
to private credit strategies is matched to the finance
Delivering for investors: The investor base of private
that managers are providing to the real economy.
credit continues to grow. Over 70% of all private credit
This is a two-fold benefit for the financial system; (i)
committed capital1 now comes from institutional
it provides a stable source of long-term capital for
investors. The diversity of private credit means that
borrowers, and (ii) it mitigates against pro-cyclical
there are also attractive strategies for smaller or non-
tendencies in the credit markets and acts as a natural
institutional investors such as family offices, which
stabiliser.
account for 5% of committed capital allocated to private
credit. New findings in the paper indicate that 38% of
capital committed to private credit today comes from
North American investors. In new evidence that the
European market is becoming a core region for private
credit, 31% of industry committed capital comes from
1
For the purposes of this paper committed capital refers to the total capital that has been allocated by an investor to a private credit manager. It includes
both drawn capital (or deployed capital) and undrawn capital (or dry powder).
5Financing the Economy 2018
1 Manager Demographics
Financing the Economy 2018 draws of roundtables and one-on-one to private credit investments, while
its content from several different interviews. Managers were also smaller managers are those that
sources. The backbone of this paper invited to submit case studies of have under $1 billion committed to
is provided by a survey conducted how their firms are contributing to private credit investments.
by the Alternative Credit Council the real economy, which you can
(ACC) and Dechert LLP (Dechert) of find throughout this paper. The industry’s total global assets
private credit managers. Almost 70 under management (AUM) continue
private credit managers responded Throughout this paper you will to grow. As we predicted last year,
to the survey; collectively they note we refer to large private credit the industry is still on track to
manage an estimated $470 billion managers and smaller private credit exceed $1 trillion in AUM by 2020,
in private credit investments, managers who count among the as shown in Figure 1. This capital is
across a broad cross-section of respondents that contributed to this being put to work, with dry powder3
jurisdictions and strategies.2 The paper. Where we describe larger as a proportion of industry AUM
survey data was then explored by managers, this refers to managers remaining below the sector’s long-
the ACC and Dechert in a series that have over $1 billion committed term average as shown in Figure 2.
Figure 1. Global private credit AUM and breakdown
Industry
of committed capital AUM
and dryand breakdown of committed
powder capital
and dry powder - Preqin FY 2017
1200.0
1000.0
800.0
691.96
600.0
420.0
400.0 388.0
337.8
280.6 298.0
241.1 269.0
217.2 414.03
200.0 135.9 177.2
107.1
38.0 43.3 54.7 76.3 246.0
29.3 28.4 32.9 195.1 175.4 214.0 217.5
73.3 99.7 111.8 105.0 116.7 132.6 132.3
15.3 24.3 31.5 39.1 38.8 42.9
0.0
31/12/2000
31/12/2001
31/12/2002
31/12/2003
31/12/2004
31/12/2005
31/12/2006
31/12/2007
31/12/2008
31/12/2009
31/12/2010
31/12/2011
31/12/2012
31/12/2013
31/12/2014
31/12/2015
31/12/2016
31/12/2017
31/12/2020 (FC)
!"#$%&$'()$*%+,-($./0 !"#$%&$10(-2345-,$623"-$./0
Sum of Dry powder $bn Sum of Committed Capital $bn Source: Preqin, ACC research
2
In this paper we use the term ‘private credit’ to describe all forms of debt finance provided by non-bank lenders.
3
For the purposes of this paper dry powder (or undrawn capital) refers to capital that has been committed to a private
credit manager but has not yet been invested.
6lendingforgrowth.org
Source: Preqin, ACC research
Figure 2. Dry powder as percentage of global
private credit AUM
Dry powder as percentage of industry AUM AUM - Preqin FY 2017
60%
51%
49% 49% 48%
50% 46% 47%
44% 45%
41%
39% Average
40% 37% 37% 37%
35% 35% 36%
34%
33%
30%
20%
10%
0%
31/12/2000
31/12/2001
31/12/2002
31/12/2003
31/12/2004
31/12/2005
31/12/2006
31/12/2007
31/12/2008
31/12/2009
31/12/2010
31/12/2011
31/12/2012
31/12/2013
31/12/2014
31/12/2015
31/12/2016
31/12/2017
Respondents to the survey are credit hubs with the majority of market, while managers based in
based around the world, as shown managers located in those two Asia-Pacific are also increasingly
in Figure 3. The United States jurisdictions. Europe (excluding prominent.
of America (US) and the United the UK) is increasingly closing
Kingdom (UK) remain key private the gap on the more mature US
Where does your firm have its
headquarters/primary asset management
centre?
Figure 3.
Where does your firm
have its headquarters/ 15% Asia Pacific
primary asset
management centre? Europe (ex. U
36%
North Ameri
19%
Asia-Pacific (ex. US)
UK
Europe (ex. UK)
North America (ex. US) 4% US
UK 25%
US
7Financing the Economy 2018
In the 2017 edition of Financing This theme is further supported investments for over six years and
the Economy we demonstrated by the findings from this year’s nearly a half have been in private
how private credit has become survey. Two thirds of respondents credit for over 10 years.
a mainstream source of finance. have been managing private credit
!"#$%"&'$()*$+",-$./-0$122&$0)&)'/&'$3-/4)52$6-27/5$/&42*502&5*8
7%
9%
Figure 4.
Less than 2 years
How long has
your firm been 2-3 years
managing 45% 18% 4-6 years
private credit
7-10 years
investments?
Greater than 10 years
21%
OurLess than 25)years
data (figure 2-3 years
suggests that 4-6 Contributors
respondents. years 7-10
to ouryearsa jurisdiction
Greater thanwe
in which 10predicted
years
Europe is home to more firms that roundtable discussions agreed imminent private credit growth in
are newer to private credit than that the European market has last year’s Financing the Economy.
North America. 10% of European become an increasingly attractive Private credit managers tell us that
managers who responded to our proposition, which is likely driving the past 12 months have been
survey reported that they have newer managers to invest in the a watershed for private credit in
been managing private credit for region. Germany, with German sponsors
less than two years, compared and borrowers increasingly
to only 4% of North American Over the last year much of this embracing private credit.
growth has come from Germany,
Figure 5. How long has your firm been managing
!"#$%"&'$()*$+",-$./-0$122&$0)&)'/&'$3-/4)52$6-27/5$/&42*502&5*8
private credit investments? (by region) Europe North America
91+$-2'/"&:
60%
50%
40%
30%
20%
10%
0%
Less than 2 years 2-3 years 4-6 years 7-10 years Greater than 10
years
Europe North America
8lendingforgrowth.org
2 Borrowers
Key takeaways:
• Private credit managers expect continued growth
across the industry but are also preparing for the
possibility of an end to the current credit cycle and
tougher economic conditions for borrowers.
• Private credit managers are increasingly lending
outside of the mid-market. Almost 25% of private
credit managers provide financing to companies with
EBITDAs of over $75 million and over 40% are lending
to companies with EBITDAs of less than $25 million.
This trend, first identified in last year’s Financing the
Economy, looks set to continue.
• Private credit managers continue to work with
borrowers to provide tailored finance solutions.
As well as benefitting from a greater choice of finance
products, borrowers are also seeking more flexibility
on loan covenants and driving a hard bargain on
pricing.
• Private credit managers continue to develop
additional loan origination pathways with non-
sponsored lending continuing to grow in relative
importance.
9Financing the Economy 2018
While small-and-medium-sized Market condition trends in relation small percentage of the lending
enterprises (SMEs) and mid-market to covenants are being closely opportunities that are available
companies4 remain crucial to the monitored by all private credit in the market. The managers
private credit industry, private credit managers. When discussing the with whom we spoke generally
managers are increasingly providing prevalence of looser covenants, have experience in dealing with
financing to both smaller and private credit managers commented borrowers in stressed or default
larger companies. Further, private that the direct lending markets situations and so believe they are
credit managers are increasingly remained relatively more disciplined well placed to weather changes in
relying on direct relationships than the more liquid leveraged the economic and credit cycle. While
and repeat business. Sponsored loan or high yield markets. Further, managers did not expect all funds
lending continues to be a significant managers to whom we spoke to fare equally well in this scenario,
part of the market. At the same stated that there is a floor which there is a strong feeling that the
time, competition in the market is they would not go below in relation sector as a whole would perform
enabling borrowers to achieve more to deal terms, and that the due relatively well in any downturn.
flexibility on loan covenants and diligence processes employed by Managers are preparing by lending
pricing. private credit managers mean that at higher positions within the
managers only invest in a capital structure, and by avoiding or
rotating away from cyclical sectors.
proximately what proportion of
nd(s) in aggregate are allocated
PRIVATE CREDIT MARKETS of banks by private credit managers
is a permanent shift. While the
debt, asset finance and trade
finance tend to be the preserve of
following private credit markets?
Lending to SMEs and the mid-
total volume of capital allocated managers who specialise in these
market remains crucial to the global
to private credit strategies has markets. Lending in these instances
private credit industry. As shown
increased, the distribution of capital tends to be secured against real
in Figure 6, half of respondents’
across different subsets of the assets such as property, goods or
capital is allocated to SMEs or mid-
private credit market has remained plant and machinery, meaning that
market borrowers. This is a similar
broadly consistent. This suggests managers need to have in-depth
finding to previous Financing the
gure XXX. Percentage of global industry committed capital allocated to
Economy surveys, reinforcing our
that there are multiple engines of
growth for private credit. Subsets
knowledge of these markets.
view that the (partial) replacement
individual private credit markets of private credit such as real estate
Large corporates
3%
5% SME/Mid-market
5% 11%
Distressed
Figure 6. 6%
3% Infrasructure
Percentage of
Real Estate
global industry
capital allocated 9% Structured products
(e.g. CLOs, CDOs)
to individual
private credit 51%
Trade Finance
3% Receivables
4% Asset-backed lending
Other
4
For the purposes of this paper we use the European Commission’s definition of an SME as a business or company that has fewer than 250 employees and
Large corporates
either an annual turnover not exceeding €50m, orSME/Mid-market Distressed
an annual balance-sheet total not exceeding €43m. We use the common understanding of mid-market
companies as companies with $10m-$70m EBITDA per annum.
Infrastructure
10 Real Estate Structured products (e.g. CLOs, CDOs)lendingforgrowth.org
Regional and size splits than European ones. This may be creditor protection frameworks
because North American managers, across Europe, means that the
Turning to our regional data (figures
and their investors, are simply market for European distressed
7 and 8), investments in distressed
more comfortable and experienced debt remains less attractive. This
debt (albeit a modest population
with the strategy. The continued may change in coming years as
represented in the analysis below)
Q6. Approximately what proportion of your
are considerably more popular
difficulties faced by European banks
to offload their non-performing loan
policymakers continue to encourage
a more active NPL market in
fund(s) in aggregate are allocated to the
among North American managers
(NPL) books, along with fragmented Europe.5
following private credit markets? Weighted, by
manager
Figure size
7. Market allocations
of average private credit fund Smaller private credit managers Larger private credit managers
(by managerFigure
size) XXX. Market allocations of average private credit manager fund
(by manager size)
50%
45% 43%
40% 38%
35%
30%
25%
20%
15%
15% 12% 11% 10% 9%
10% 8% 7% 7% 7% 7%
6%
Q6. Approximately what proportion of your1%
5% 5%
5% 3% 3%
1% 2%
fund(s) in aggregate are allocated to the
0%
Large corporates SME/Mid-market Distressed Infrastructure Real Estate Structured Trade finance Receivables Asset-backed Other
following private credit markets? Weighted, by products (e.g.
CLOs, CDOs)
lending
region Smaller private credit managers Larger private credit managers
Figure 8. Market allocations of average
private credit manager fund (by region) North America Europe 12
Figure XXX. Market allocations of average private credit manager fund
(by region)
50%
45%
45%
41%
40%
35%
30%
25%
19%
20%
15% 13%
10%9% 9%
10% 7% 8%
6% 5% 5% 5% 5%
4% 4%
5% 3% 3%
0% 1%
0%
Large corporates SME/Mid-market Distressed Infrastructure Real Estate Structured Trade finance Receivables Asset-backed Other
products (e.g. lending
CLOs, CDOs)
North America Europe
In March 2018, the European Commission presented a package of measures to address the risks related to high levels of NPLs in Europe.
5 11
11Financing the Economy 2018
EXPECTATIONS Examining the respondent data Respondents also anticipate
on a net basis (subtracting the significant growth in the distressed
When asked whether they plan
number of respondents planning debt market. When pressed on
to deploy more, less, or the same
‘less investment’ from those this point, managers identified
amount of capital to the various
planning ‘more investment’), a third the expectation that interest rates
private credit markets (Figure 9),
of respondents plan to increase would rise making it harder for
respondents were clear: more
allocations to SMEs and/or some borrowers to meet their
respondents predict increasing their
mid-market companies over the existing loan commitments or
allocation than decreasing it across
coming three years. This may be to refinance. Further, various
every sub-sector of the private
because, as one private credit indicators,including the sheer length
credit market. Optimism is highest
manager put it, “borrowers are of the current credit cycle, suggest
in relation to SME and mid-market
more open to alternative funding that the economy is entering a
Figureas6.well
lending, Percentage
as distressedof
andglobal industry committed
than they were five years ago”. period where continued economic
capital allocated
asset-backed lending. to individual private credit markets
growth may be less certain than in
the recent past.
Q7. How do you see your investment in
these private credit markets changing
Figure 9. How do you see your
over the
investment next
in these three
private credit years? Less investment Same level of investment More investment
markets changing over the next
three years?
Figure XXX. How do you see your investment in these private credit markets
changing over the next three years?
100%
12%
90% 22%
28% 27% 24% 24%
29%
35%
80% 42% 42%
70%
60%
50% 76%
66% 66% 64%
59% 62% 61%
40%
45% 56%
49%
30%
20%
10%
13% 13% 12% 10% 12% 10% 12% 12%
9% 8%
Regional
0% and size splits than European ones. This may along with the fragmented creditor
Large Corporates SME/Mid-market Distressed Infrastructure Real estate Structured Trade finance Receivables Asset-backed
be because North American protection frameworks across Other
Turning to our regional data, products (e.g. lending
managers, and their investors, CLOs, CDOs) Europe, means that the market for
investments in distressed debt
are simply
Less investment more comfortable
Same level of investment and European distressed debt remains
More investment
(albeit a modest population
experienced with the strategy. less attractive. This may change
represented in the analysis above)
The continued difficulties faced by in coming years as policymakers 13
are considerably more popular
European banks to offload their continue to encourage a more
among North American managers
non-performing loan (NPL) books, active NPL market in Europe.4
12lendingforgrowth.org
This optimism in the industry The third line of defence cited was
is accompanied by an acute having adequate workout resources
awareness that we are in a long and expertise. Having access to staff Case study
credit cycle that could perhaps (either in-house or via third parties) Clients advised by
be nearing its end. Many of with knowledge of default scenarios
Allianz GI provide
the conversations we held with and restructuring is becoming an
managers centred on their firm’s increasingly relevant consideration
financing to
preparedness for a downturn and for managers and one they use to infrastructure project
their expectations as to what the differentiate themselves from their Clients advised by Allianz GI
reaction would be in the private competitors. provided €400m of financing to
credit market. Sound underwriting an Italian infrastructure project
was singled out as the key first Moving into the distressed debt
supporting the construction of
defence mechanism against market also provides opportunities
parts of the Venice ring road.
deteriorating credit conditions. for managers to finance a larger
The motorway assets are an
As one private credit manager population of borrowers. As one
essential link in the Italian and
explained, identifying a strong private credit manager explained,
European motorway system and
company and matching the lending any bank removing distressed debt
are vital for international trade
structure to its cashflow provides from its loan book would provide
between western, central, and
protection even if the “environment an opportunity for a private credit
eastern Europe.
around it is about to collapse”. manager to develop a relationship
with borrowers who have previously
The second line of defence only used bank financing.
cited is being proactive when
monitoring loans and engaging with A borrower’s inability to repay a
borrowers. This is where a sound loan is often less a reflection of
operational set up and discipline that borrower’s financial strength,
in data gathering, monitoring and more a reflection that the loan
and management becomes key. was made on the wrong terms. For
Our previous research shows many borrowers in distress, debt
the industry is increasing its refinancing may also be preferable
focus on upgrading operational to giving up equity.
infrastructure to integrate data
from their borrowers with other
relevant datasets to support risk
monitoring. Managers also stressed
the importance of risk mapping and
stress testing of their portfolios.
This type of forward-looking
assessment would typically consider
how borrowers may fare under
more challenging (but plausible)
market scenarios, and how this
would affect managers’ overall
portfolio.
13Financing the Economy 2018
Regional splits One example of where there is an to help reinvigorate this as a
even larger disparity in allocations source of finance for borrowers.
There is a difference of approach
to structured products, where 29% Despite recent revisions to the EU
regarding allocations to certain
of North American respondents Securitisation Regulation, European
categories between North American
plan to deploy additional capital, respondents seem to be reserving
and European respondents. As
compared to only 4% of European judgement for the time being. In
shown in Figure 10, on a net basis,
respondents. In Europe, appetite for the US, meanwhile, the removal
38% of North American respondents
these products remains low amidst of risk retention requirements for
anticipate they will deploy more
greater regulatory restrictions. Many some collateralised loan obligations
capital to distressed debt over the
private credit managers with whom is likely an important factor in
coming three years, compared to
we spoke support improvements driving optimism around structured
24% of European respondents.
in securitisation frameworks products.
Q7. How do you see your investment in these
private credit markets changing over the next
three10.years?
Figure Net
How do you see‘more investment,’
your investment in these by region
private credit markets changing over the next Europe North America
three years? (Net percentage of ‘more investment’
responses,Figure
by region)
XXX. How do you see your investment in these private credit markets
changing over the next three years? (Net percentage of ‘more investment’
responses, by region)
40% 38%
37%
35%
31%
30% 29%
26%
25% 24% 24% 25%
25% 23%
21%
20%
14% 15%
15%
10% 11%
10%
7%
5% 5%
5% 4%
0%
0%
Large Corporates SME/Mid-market Distressed Infrastructure Real estate Structured Trade finance Receivables Asset-backed Other
products (e.g. lending
CLOs, CDOs)
Europe North America
15
14lendingforgrowth.org
BORROWERS BY SIZE We also see an increasing the same. Instead, private credit
dispersion of borrowers’ EBITDAs. managers are increasingly lending
As shown in Figure 11, the average
In 2017, 39% of private credit to smaller companies,those with
borrower EBITDA6 reported by all
managers reported an average less than $25 million EBITDA,and
respondents is $44 million, up from
borrower EBITDA of between $25 larger companies, with over $100
$38 million in 2017.
million and $75 million; this year million EBITDA, as shown in Figures
only 32% of respondents reported 13 and 14.
What is the average EBITDA* (in USD millions) of your firm’s borrowers?
2%
Negative EBITDA (e.g.
17% 14% potential distressed loan)
Figure 11. What 3%
is the average Less than $5m
EBITDA (in USD $5m - $9.9m
millions) of your 8%
$10m - $24.9m
firm’s borrowers?
$25m - $49.9m
Average: 8% 24%
$44 million $50m - $74.9m
$75m - $99.9m
24%
Greater than $100m
!"#$%&'%$"(%$)*&+#,%$#-.($%,/#0%'&1(%$"#$%)/2%3#4(%5&$"&0%)/2-%*-&6#$(%
Negative EBITDA (e.g. potential distressed loan) +-(7&$%'$-#$(.)8
Less than $5m $5m - $9.9m
$10m - $24.9m $25m - $49.9m 3% 3% $50m - $74.9m
$75m - $99.9m Greater than $100m
Figure 12. What is 16% 8%
Less than $1m
the typical target
loan size that you $1m - $4.9m
make within your $5m - $9.9m
private credit
strategy? 26% $10m - $24.9m
$25m - $99.9m
Average:
$61 million 44% $100m - $249.99m
9(''%$"#0%:;3 :;3% ??3 :@3%??3 :;A3% ??3 :B@3%??3 :;AA3% ??3
EBITDA based on either GAAP or IFRS accounting standards and excluding any addbacks
6
15Financing the Economy 2018
As per Figure 13, 17% of There has been a trend since
respondents reported lending to 2016, for private credit managers
Case study companies with EBITDAs of more to lend to companies with under
Cheyne Capital than $100 million, more than $25 million in EBITDA, as shown in
double the number reported in Figure 14. Those firms gain access
finances established UK
2017. This is a clear indication to the capital they need to support
housebuilder that the private credit industry is their growth without surrendering
Cheyne Capital provided a increasingly able to take on the any equity, and benefit from
£35 million five-year junior deals that were once entirely the tailored finance solutions.
loan to Larkfleet Homes, an domain of banks (a trend discussed
SME regional housebuilding in Financing the Economy 2017).
company headquartered in the Moving closer to loan sizes seen in
East Midlands area of the UK, to public bond markets.
finance its expansion plans and
grow its regional presence.
Figure 13. Percentage of respondents allocating to
companies with EBITDAs in excess of $100m
!"#$"%&'(")*+)#",-*%."%&,)'//*$'&0%()&*)$*1-'%0",)20&3)456789,)0%)":$",,)
*+);)?"'# @
*%@
?"'#
20% 17%
15% 13%
10% 8%
Case study 5%
OCP Asia provides
0%
funding for Australian 2018 2017 2016
house-and-land project
Hong Kong based OCP Asia
Q19. What is the average EBITDA*
provided a $70 million loan (in USD millions) of your firm’s
to Welsh Group to fund a borrowers?
Figure By year
14. Percentage of respondents allocating
new house-and-land project
to companies with EBITDAs of less than $25m
in Melbourne, Australia. The Percentage of respondents allocating to companies with EBITDAs of less than
financing will support the $25m (year-on-year)
development of 400 lots and an 44% 42% 43%
apartment site in Melbourne.
39%
OCP Asia previously provided
33%
34%
a $105m loan to finance Welsh
Group’s development of a 1300- 29%
lot house-and-land estate, also 24%
in, Melbourne.
19%
14%
9%
4%
-1%
2018 2017 2016
61
16lendingforgrowth.org
LOAN ORIGINATION between private credit managers position of providing multiple
and borrowers; 40% of respondents rounds of funding to the same
As shown in Figure 15, the most
report using such channels. As the borrower, a trend identified in last
common way of originating lending
private credit industry matures, year’s Financing the Economy.
flow is through direct relationships
managers are increasingly in the
!"#$%&'%$"(%)*'$%+*))*,%+"#,,(-%*.%'*/0+&,1%2*$(,$&#-%+0(3&$%*22*0$/,&$&('4
2% 2%
5% Direct relationship
with a borrower
Figure 15. 10%
Private equity firms
What is the most
common channel 40% Banks/credit institution
11%
of sourcing Other industry relationships
potential credit
Consultants
opportunities?
Other (please specify)
Peer-to-peer platforms
31%
Q26. WhatSponsoredpercentage ofsupports
lending has traditionally This
7
financing
the hypothesis provided
requires managers byto invest
your firm typically involves anon-sponsored
financialteams, sponsor
5&0(+$%0(-#$&*,'"&2%6&$"%#%7*00*6(0
80&9#$(%(:/&$;%.&0)'Financing the Economy 2018
Q21. What is the most common
Regional and size splits
channel of sourcing potential credit
North American and European private credit managers source their loans in different ways, with 38% of North
opportunities? By region
American respondents reporting that private equity firms are their most common channel, while 41% of
European managers reported that direct relationships with borrowers was the most common channel.
Figure 17. What is the
Figure XXX. most
What common
is the channel
most common channel of sourcing potential credit
Europe North America
of sourcing potential credit opportunities?
opportunities?(by
(By region)
region)
45%
41%
40% 38%
35%
35% 33%
30%
25%
19%
20%
15%
11%
10% 7%
4% 4% 4% 4%
5%
0%
Banks/credit Consultants Direct relationship Other (please specify) Other industry Peer-to-peer Private equity firms
institution with a borrower relationships platforms
Europe North America
BORROWER TERMS Loan covenants are a key means by
which managers can manage credit 74
Private credit remains a borrower’s
Case study risk and protect their interests.
market. Borrowers have both a
Covenants do not, however, exist in
CVC Credit Partners greater choice of lenders and more
isolation; less stringent covenants
provides financing negotiating power. Borrower fees,
do not necessarily equate to less
to Spanish invoice- coupon quantums and covenants
robust lending practices. Private
discounting operator for are a good measure of this; our
credit managers with whom we
second time data on all three indicates that
spoke highlighted how the ability
borrowers of private credit are in a
In August CVC Credit Partners to identify and analyse viable credit
strong position.8
provided a second round of opportunities was more critical than
financing to the Gedesco Group As shown in Figure 18, almost ever. The sophistication of market
(Gedesco) following a deal in four times as many respondents research, due diligence and credit
2015 to support the growth of report that arrangement fees are risk assessment processes are all
the business. Headquartered decreasing rather than increasing. becoming crucial differentiators.
in Valencia, Spain, Gedesco Twice as many respondents Further, while private credit
is the largest independent reported financial covenant managers may be showing more
specialist invoice-discounting protection weakening rather than flexibility around covenants than in
and factoring operator in the those that reported strengthening previous years, there are still risk
country. The business has more over the past year, as shown in baselines they will not cross.
than 25 offices across Spain. Figure 19. We also see a mixed
This is indicated by the relatively
picture on the headroom provided
high proportion of private credit
to borrowers against their financial
managers (60%) who report no
covenants as shown in Figure 20.
change in financial covenant
While the picture on loan coupons
protection during the last 12
is more nuanced, a third of
months (see Figure 20).
respondents report that coupons
have lowered over the last 12
months.
8
These findings are in keeping with other industry research. For instance, a recent paper by Preqin found that 63% of private credit managers believed that
lending terms became more borrower-friendly in the preceding 12 months. See: Preqin,“Private Debt Fund Manager Outlook” 2018.
18lendingforgrowth.org
Figure 18. How has your Figure 19. How have Figure 20. How has
coupon for a potential your arrangement fees financial covenant
loancoupon
XXX. How has your changed
for aover the loanFigure
potential changed
changed over
XXX. How have yourthe past fees
arrangement Figure protection changed
XXX. How has financial covenant protection
over the past
past year? year? year?
changed over the past year? over theover
changed pastthe year?
past year?
5%
21% 18% 27%
46%
60%
33% 13%
77%
1 2
1 2 3
Higher Higher Less financial# $ %
covenant protection
Lower Lower
More financial
No noticeable change No noticeable change covenant protection
No noticeable change in
covenant protection
FigureFigure 21.isWhat
XXX. What is the
the typical typical headroom provided
headroom
providedfor
for borrowers against
borrowers against theirtheir financial covenants?
financial
covenants? Case study !"
3% Beechbrook Capital
Less finances leading global
than 20% executive search
10%
20%
specialist
29%
Beechbrook Capital’s UK
25%
20% SME credit fund provided a
30% unitranche loan to Leathwaite, a
global human capital specialist
12% More than 35% with offices in London, New
25% 35%
York, Hong Kong and Zurich.
The investment will help
Leathwaite to accelerate its
worldwide expansion, launch
1 2 3 4 5 6 new business streams and invest
in proprietary technology.
19Financing the Economy 2018
Regional and size splits the past year, while only 8% report When we compare the use of
greater prote ction. This compares covenant terms between larger
As in other matters there is regional
to 26% of European managers and smaller managers, as shown in
variation around changes to
reporting less covenant protection, Figure 23 we see that 44% of larger
financial covenant protection. As
and 11% reporting greater covenant private credit managers’ report
shown in Figure 22, 38% of North
American respondents report less Q24. How has financial covenant
protection. that covenants have lessened over
financial covenant protection over protection changed over the past the past year; only 4% of smaller
managers reported the same.
year? By region
Figure XXX. How has financial covenant protection changed over the past year? (By
region)
Figure 22. 70%
63%
How has financial 60%
54%
covenant protection 50%
changed over the past 40%
38%
year? (by region) 30% 26%
20%
11%
Q24. How has financial covenant
10% 8%
Europe North America
protection changed over the past
0%
Less financial covenant protection More financial covenant protection No noticeable change in financial
covenant protection
year? By manager size Europe North America
78
Figure XXX. How has financial covenant protection changed over the past year?
(By manager size)
100%
Figure 23. 90%
88%
How has financial 80%
covenant protection 70%
60%
changed over the past 50% 44%
year? (by manager size) 40%
39%
30%
20% 17%
8%
10% 4%
Less than $1bn Greater than $1bn 0%
Less financial covenant protection More financial covenant protection No noticeable change in financial
covenant protection
Less than $1bn Greater than $1bn
79
CONCLUSION at all stages of development as We also continue to see specialised
well as to more established blue- managers providing finance to
While SMEs and mid-market firms
chip companies. This competition niche markets. This ensures that
remain central to private credit
between private credit managers borrowers in these markets are able
lending, private credit managers are
benefits borrowers, a greater to source finance from lenders who
moving beyond these markets. The
proportion of whom can now see know their industry and are able to
flexibility of private credit facilitates
private credit as a mainstream work with them on tailored finance
bespoke financing to borrowers
source of finance. solutions.
20lendingforgrowth.org
3 Investors in Private Credit
Key takeaways:
• The investor landscape of private credit is becoming
increasingly diverse, with a wide range of investor
types, both institutional and otherwise, committing
capital to private credit.
• The majority of capital committed to private credit
comes from North America.
• There is still a significant number of investors
committing capital to the industry for the first time,
indicating that opportunities remain.
• Investors of all types have a choice of positions in
borrowers’ capital structures to match their risk and
return appetites.
• Private credit managers are flexible when it comes to
working with investors: a strong majority are willing to
run separately managed accounts.
21Financing the Economy 2018
INVESTOR DEMOGRAPHICS
Case study Our data indicates that 38% of capital committed to private credit comes
from North American investors. A further 31% of industry committed
LendInvest capital comes from Europe (excluding the UK) in another sign that the
completes £16 million European market is becoming a core region for private credit.
development deal in UK
Investment in the private credit sector is also becoming more institutional.
commuter town
As shown in Figure 24, over 70% of all private credit committed capital
LendInvest completed a £16 comes from pension funds, insurers, and sovereign wealth funds. Such
million financing deal with investors may have been drawn to private credit as an alternative to
established development finance their traditional fixed income allocations in the years following the global
borrower, Yogo Group. The deal financial crisis, as investment-grade corporate bond yields (along with
was completed in three weeks government bond yields) collapsed.9 Private credit can also offer investors
from initial introduction to site a range of risk/return profiles. For example, senior secured debt backed
purchase. The development by ample collateral can offer low but attractive yields, while unsecured,
finance loan will fund the part- unitranche10 or leveraged loans can offer stronger yields to investors who
conversion and rebuilding of an are willing to take on more risk. What began as a cyclical trend is now a
historic building, as well as the structural shift: an increasing number of institutional investors now have
construction of new units. specific alternative credit allocation categories in their portfolios.11
Private credit equally remains open to smaller investors such as family
offices. Our analysis indicates that on average 5% they account for of
capital committed to private credit, as shown in Figure 25. Family offices are
typically seen as more flexible and, along with high-net-worth individuals
(HNWIs), tend to have greater risk appetites than their institutional peers.
Further, such investors tend to make smaller commitments, and thus
do not face the institutional investor challenge of finding funds large
Case study enough to accept them. One more category of investor reported by our
UK community housing respondents is worth highlighting: employees and staff. Notably, over 70%
secures financing from of respondents reported that their staff had invested capital with them.
M&G Investments This shows an alignment of interests between private credit managers and
their investors.
Watford Community Housing
secured £65 million of financing Regional and size splits
from M&G, enabling the
Insurers account for 38% of committed capital to European respondents;
continued construction of 675
twice the percentage allocated to their North American respondents.
homes over the next three years
As mentioned in the first section of this paper, European insurers are
in the UK. The 32-year financing
becoming increasingly interested in allocating private credit to fixed income
secured by Watford Community
components of investors’ portfolios.
Housing will facilitate its
ambition of building 1,000 Across our survey, smaller private credit managers draw a larger
affordable homes by 2020, proportion of their capital from HNWIs and family offices. This divide
of which over 100 have been is likely caused by the fact that institutional investors tend to make
already completed. larger allocations and often have internal policies preventing them from
representing over a certain percentage of a manager’s assets. Family offices
and HNWI, meanwhile, can be more flexible.
https://www.businessinsider.com/10-year-isnt-the-government-bond-yield-you-should-be-focusing-on-2018-5?IR=T
9
A combination of a senior tranche of debt and a junior tranche of debt in a single loan with a blended return.
10
Gapstow Capital Partners, How do U.S. Public Pension Plans Allocate to Alternative Credit?, October 10, 2018.
11
22lendingforgrowth.org
23. Investor region breakdown
centage of total private credit
Figure 24. Approximately what Figure 25. Investor type breakdown
proportion of your current investors as percentage of total private credit
are based in the following regions? AUM
Figure 23. Investor region breakdown as percentage of total private credit AUM !"#$%&'()*'+*,-'.$-*/"01$2#*3"#&02*3$/02$-*.4*0)1#52'"*24/#
1% 3% 3%
4% Pension funds
US
Insurers
14% 5%
North America (ex. US)
3%
32% 5% Other
UK 35%
Sovereign wealth funds
Europe (ex. UK)
15%
Family offices
Middle East/Africa
31% 6% Private banks
Asia-Pacific
13% 31%
High-net-worth individuals
South America
Employees and staff
US
Investor Breakdown (allocation to manager)
North America (ex. US) UK Europe (ex. UK) Middle East/Africa Asia Pacific South6#)50')*+7)&5
America 8)57"#"5 92:#" ;'1#"#0,)*(#$-2:*+7)&5Financing the Economy 2018
INVESTOR EXPERIENCE
Investors are increasingly familiar with private credit and how to integrate the strategy into their overall
investment portfolio. As shown in Figure 28, half of all respondents report that less than a fifth of their investors
were allocating to private credit for the first time; an average of 25% of respondents’ investors are on their first
allocation to private credit. As private credit managers with whom we spoke explained, investors in private
credit find the uncorrelated returns and illiquidity premium on offer very attractive in the current climate.12 An
investment in private credit can also offer a wide variety of risk and maturity profiles, depending on the capital
structures in which a manager invests, and the type of lending activity undertaken.
Private credit investors continue to show a preference for higher positions in the capital structure, with more
than 40% of capital allocated to senior secured debt strategies (Figure 29). This preference is likely due to many
!"#$%&'()'*$#+'%,-%.,/(%0*1'2$,(2%#('%-0(2$
investors still placing greater value on the loan’s security rather3than
$04'%#55,)#$,(2%$,%&(01#$'%)('60$7
the potential to make an outsized return,
as well as the stage the economy finds itself in the credit cycle.
7%
Figure 28. 10%
What percentage 31% 0-10%
of your investors 11-20%
are first-time
allocators to 21-40%
private credit? 41-60%
29%
Average: 81-100%
25%
24%
!"#$%&'((()'*+,"-+.'/-%$0-$%&'+..10+-"12/'13'+4&%+#&',%"4+-&'0%&5"-'
6+2+#&%'3$25
8398: 993;8: ;93lendingforgrowth.org
Regional and size splits
There is reason to believe that private credit has room to grow in both of its
largest regions. On average, the percentage of first-time investors in North
American and European private credit managers is remarkably similar: 26%
Q13. What percentage of your
The image part with relationship ID rId2 was not found in the
file.
and 23%, respectively. This suggests that there continues to be a strong
investors are first-time allocators to
pipeline of first-time investors in both of these regions.
private
Figure 30. credit? By region
What percentage of your investors are
Europe North America
first-time allocators to private credit? (by region)
Figure XXX. What percentage of your investors are first-time allocators to
private credit? (By region)
35% 33% 33% First time investors in
private credit: 26% of North
30% North America average: 26%
26% 26% 26%
Europe average: 23% America managers‘ investors
25% 22%
First time investors in
20%
16% private credit: 23% of European
15%
managers‘ investors
10%
6% 5% 6%
5%
0%
Case study
0-10% 11-20% 21-40% 41-60% 81-100%
Europe North America Permira invests in
38 Italian clothing brand
When we compare larger and smaller private credit managers (Figure Permira Credit Solutions III
31) there is a much starker divide. On average, only 18% of investors in (PCS3) invested in the senior
larger private credit managers are first-time investors in private credit, secured floating rate notes
compared to 33% of investors in smaller private credit managers. It is not of TwinSet, a luxury Italian
unreasonable to assume that a first-time allocator to private credit would women’s clothing brand. This
want to start with a relatively small allocation and increase it over time; was a primary transaction with
smaller private credit managers tend to have lower minimum allocations. PCS3 acting as lead arranger.
As such smaller private credit managers may provide an important entry- The deal was originated through
point for investors. a strong relationship with the
sponsor, The Carlyle Group.
Q13. What percentage of your
The image part with relationship ID rId2 was not found in the
file.
investors are first-time allocators to
private credit? By manager size
Figure 31. What percentage of your investors are
Smaller private credit managers
first-time allocators
Figure to private
XXX. What percentage credit?
of your investors (by manager
are first-time allocators to size)
private credit? (By manager size)
Larger private credit managers
40%
36%
35% 31% Smaller manager average: 33%
30% 28% 28% Larger manager average: 18%
25%
25% First time investors in
19% 19%
20% private credit: 18% of larger
15% managers‘ investors
10% 8%
6%
First time investors in
5%
private credit: 33% of smaller
0%
0-10% 11-20% 21-40% 41-60% 81-100%
managers‘ investors
Smaller private credit managers Larger private credit managers
39
25Financing the Economy 2018
MANAGED ACCOUNTS private credit managers create accounts to feature bespoke
bespoke investment accounts for fee arrangements. 84% of all
The growing influence of
individual investors. These accounts respondents reported being open
institutional investors in private
give investors influence over how to the idea of managed accounts,
credit is evident in the use of
their investments are managed and as shown in Figure 32, albeit at
managed accounts for single
give them greater transparency. different sizes.
investors. In such arrangements
It is also common for managed
At what level are you able to offer managed account structures for single
investors?
2%
Do not offer managed
16% 18% account structures
Figure 32. Less than $50m
At what level are
you able to offer 7% $50m-$75m
managed account $75m-$100m
structures for $100m-$250m
single investors? 33% 16%
$250m-$500m
Greater than $500m
8%
Do not offer managed account structures Less than $50m
$50m - $75m
CONCLUSION The growing influence $75m
of - $100m
institutional investors in private Case study
$100m
As - $250m
more investors commit capital $250m - $500m
credit will have profound
to private credit (or increase their Monroe Capital
Greater than $500m
allocations thereto), the industry is
implications for the industry.
supports
Private credit managers may find
catering to an ever-expanding list of
their due diligence processes recapitalisation of USA
investor requirements. The volume brand implementation
subject to greater scrutiny before
of allocations is in turn making
gaining allocations. Whilst managers company
the industry more appealing for a
are adapting to meet these
greater variety of investors, creating Monroe Capital LLC acted
expectations, continued dialogue
a virtuous circle. as lead arranger and
between investors and managers
administrative agent on the
will be essential if private credit is to
funding of a $25.5 million
reach its full potential.
unitranche credit facility
to support the growth and
expansion of Atlas Sign
Industries, Inc. (Atlas). Atlas is an
international provider of brand
implementation products and
services.
26lendingforgrowth.org
4 Fees
Key takeaways:
• Private credit managers offer a wide variety of fee
arrangements; these arrangements are affected by,
among other things, their strategies, risk levels, return
expectations, and fund structures.
• Fee levels remain competitive across the sector; a
quarter of all respondents report their management
fees being lowered over the past two years.
• From the sample of managers that were polled, the
average management fee charged is 1.29%, and the
average incentivisation percentage is 15%. Over 80%
of private credit managers would consider further
lowering their rates for the right investor.
• The vast majority of private credit managers charge
management fees only on drawn capital; preferred
returns, hurdle rates and clawbacks are also popular
in the industry.
27Financing the Economy 2018
Q31. Which fees d
There is no single traditional fee TYPES OF FEES business
Figure 33. from yo
investments? (Se
model in the private credit industry.
As shown in Figure 33, over 90% Which fees do you
Rather, private credit managers
arrange their fees based on,
of respondents report charging derive as a business
amongst other things, the strategies
management fees. In most cases, from your private
these fees are calculated as a credit investments?
they pursue and the loans in which
they invest (and the concomitant
percentage of drawn capital (see Figure
(select all that XXX. Which fees do
apply)
below). 79% of respondent reported
targeted returns and risk levels), invest
charging a performance fee. These
the type of funds they run (whether 93%
tend to be more common in funds 100%
they are closed or open-ended), 79%
with higher targeted returns. As 80%
and the levels of leverage they
such, they are particularly common
deploy. This means that it can be 60%
in levered senior secured debt 33%
challenging to describe ‘typical’ 40%
funds, as well as in mezzanine debt
private credit fee structures. In 20%
funds and distressed debt funds.
general, the greater the target
0%
return, the higher the level of
Management Performance Arrangement C
fees. At the same time, investors fees fees fees
are often subject to lower fees
for investing in closed-end funds
invested in less liquid assets.
To better understand how a 10% of their flagship fund). Among likely to report charging incentive
private credit manager’s strategy the five most common strategies, fees to reflect the additional work
affects its fee arrangements, we those managers with significant that is typically required to deliver
split the results by the markets in loans to large corporates are most outperformance in this type of
Q31. Which fees do you derive as a business
which respondents report having a likely to charge management fees, investment strategy.
significant level of capital invested As shown in Figure 34, a distressed
from your private credit investments? (By
(defined for our purposes as over debt focused manager is most
manager sizes, select all that apply)
Figure 34. Which fees do you derive as a
Management fees Performance fees
business from your private credit investments?
(by manager strategy)
Figure XXX. Which fees do you derive as a business from your private credit investments? (By
manager strategy)
100% 94%
90% 92%
87% 88%
90%
82% 81%
80% 76% 76% 75%
70%
60%
50%
40%
30%
20%
10%
0%
Large corporates SME/Mid-market Distressed Real Estate Structured products
(e.g. CLOs, CDOs)
Management fees Performance fees
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