The current challenges in the global economy will test the skill and experience of private debt managers. As the appetite across banks and other lenders adjusts these challenges can also provide new opportunities for lenders that are nimble and focused.
Andrew Davies and John Empson, partners and co-heads of private credit at CVC are optimistic about the future of the asset class. They tell Private Debt Investor that well-established firms like CVC, with strong diverse product offerings and relationships across the alternatives space, are poised to see further growth in market share.
What are the most important trends that you're seeing in the private debt market currently?
Andrew Davies: Private credit (private asset alternatives) are now a larger piece of the institutional markets asset allocation. As the European market in private credit continues to develop and mature, investors have been adding to their allocations with experienced private credit managers of scale in Europe. Post-covid, the theme of traditional underwriters finding it more challenging to support M&A with flexible financing solutions has accelerated, and therefore so has the adoption of private credit products, particularly in the sponsor-backed segment of the market.
The mid and upper-mid market still remain very relevant to private credit managers, however wider opportunities in the large cap universe in recent months have grown tremendously. Today, given ongoing volatility across liquid public markets, the traditional financing market is restricted in its ability to execute. Private markets, due to the nature of their capital, are now very clearly looking to continue to deploy into this unique and wider opportunity. That’s where the universe is today.
John Empson: In our view capital has flowed towards private markets because institutional investors have got more and more comfortable that established firms, can utilise their expertise and networks, and the data they have aggregated over many years, to efficiently diligence and execute a broader spectrum of investment opportunities.
When you combine this with the relationships our firm and our team have built over a long period of time with financial sponsors, management teams and their advisors, the opportunity feels pretty compelling. For us, this has been instrumental in continuing to aggregate more capital for the private credit business we manage. In turn, as these pools of capital have become scaled and more relevant, there is increasing adoption from issuers, as Andrew mentioned.
Relationships are essential to our business. From our perspective, the growth of our relationships, and the changes in the market environment over the last 18 months or so, means that there’s a big tailwind pushing product opportunity towards us.
Will that make it difficult for new entrants to come into the private debt market, especially in Europe?
AD: If you look at every institution like ours, you’ll see individuals who have built very strong relationships in originating, executing and managing leverage credit over decades and today. It feels difficult for a new participant to enter the European market quickly unless it comes with a very aggressive form of capital to displace the market on terms. Again, it takes time to build the brand and the breadth of relationships across multiple jurisdictions to be successful in Europe.
Where we also see success, is if you have the diversity of capital and the infrastructure – like we do – is the ability to assess and provide flexible solutions across all financing needs (secured, junior, liquid, private). This further solidifies relationships and gives us a greater ability to do repeat business with the sponsors that we want to work with.
There are a lot of niches within direct lending, but those niches will remain quite small. So, if you’re looking at where the deployment, the scale and the relationships are evolving, it’s very much with institutions that can provide a whole suite of optionality for sponsors.
To what extent do you still see Europe as a growth market for private debt?
JE: Currently, our perspective is that there remains significant potential for growth in the private credit space across European markets.
Across Europe, banks have increasingly turned to a distribution rather than hold model which produces opportunities across each of the local markets in which we operate. In Europe, we believe that local presence, knowledge, understanding and relationship drives incremental origination and investment opportunity.
Moreover, unlike the US market, where there has been significant banking consolidation over the last 30 years or so, the European market has remained more fragmented. That US banking consolidation certainly was a contributor to the focus on distribution within the consolidated banking groups that now operate in that market and the growth of assets to be managed. Perhaps longer term European markets could develop further and this could represent further opportunity for private markets here.
Larger sponsors are recognising that the product, its flexibility, the direct approach, the individuals they're dealing with and the security of the execution make private debt an extremely attractive financing counterpartyAndrew Davies
What are the key risks and opportunities for private debt as we head deeper into a difficult macroeconomic environment?
AD: It will probably be mid-2023 until we have the data sets to look at asset level performance. The less mature private debt platforms are in their third or fourth vintage which have been deployed through the last 5 years – they haven’t really experienced a period of sustained macro weakness like we are anticipating in the year ahead. Performance across these strategies and the return on capital during a period will allow investors to differentiate across managers in their underwriting and execution. This is both a risk and an opportunity – depending on how you look at it as a platform.
Institutions that have access to a wider investment platform and who have been investing in and financing private assets for a long period of time should, in our view, be better placed to outperform. They have experienced professionals with broad market connections and large networks which support and position them to understand the industries and the corporates that they’re lending to.
JE: The key when you get into a more challenging environment is to keep in mind that there’s going to be situations where people are going to need help. That could be help to make or grow by acquisition, help to refinance because of existing debt maturities or help to fix challenges. We and other market participants as well as issuers will have to adapt. Generally the key for us is to be a thoughtful solution provider.
Relationships are essential to our businessJohn Empson
In my experience, opportunity and capital tends to flow to the firms that have broad based experience with people who have seen and operated in diverse situations and who can adapt to the environment around them.
Do you expect to make changes in the types of business you lend to?
JE: As Andrew mentioned earlier, the balance has tipped more towards large cap or upper-mid market deals. That said, we do continue to see some very interesting smaller deals where there are strong opportunities for growth and market consolidation, and we will continue to support these.
In terms of business segments that we’ve positioned ourselves to support over the last 18 months or so, for us it’s just about great credits. Put simply – we provide financing to strong well-manged businesses and we seek to generate risk adjusted returns for those who invest with us, through the repayment of the facilities we provide, plus the interest and fees that are generated over the life of each deal. So, we’ve naturally positioned ourselves towards more defensive segments and the more resilient end of the marketplace.
More specifically, we do like lending to what we call ‘needs businesses’. Businesses that we believe will have cashflow coming in day in, day out, as a result of societal trends and the way we live. We’ve tried to stay away from sectors that can be materially impacted by external factors, understanding that most businesses are not completely immune to the environment around us.
Will private debt see increased opportunities with retail investors in the coming years?
AD: We’re all trying to solve for this. The retail market has always been the big untapped universe for private markets. Every institution – private equity and private credit – in acquisition financing is looking for ways to expand beyond the traditional sources of investor capital. Although the regulatory environment has been quite restrictive, we’ve seen, particularly in the US, the creation of semi-liquid products that sold to what we could call a high-net-worth retail investor. That’s been successful and has seen impressive flows in recent years where investors have been seeking high quality stable yield assets.
In Europe, there are a lot of discussion around it and some structures have been put in place, but we don’t see it as being a huge driver of asset flows, not in the immediate term at least. I suspect that traditional asset allocators to private credit will continue to be the primary driver of the European market opportunity as we look in the years ahead.
Are you optimistic for the future of private debt?
AD: The opportunity in Europe is twofold: the continued growth across the core mid and upper-mid market; and, the extension of what we are experiencing today where the product is becoming more frequently accessed in larger cap transactions.
Larger sponsors are recognising that the product, its flexibility, the direct approach, the individuals they’re dealing with and the security of the execution, make private debt an extremely attractive financing counterparty. I anticipate that we’re not here to just solve the current market opportunity but should become, like the US, a more frequent source of capital for the financing markets across the size spectrum of issuers.
We've still got a bit of a way to go. The opportunity is definitely there. The market is definitely there. The asset allocation should continue to scale, and our job is about making sure the performance remains robust.
JE: There are many incremental ways that private debt can grow. We have focused today on traditional forms of leverage finance, where as we have mentioned, there has be significant adoption. But there are so many other segments of the market to go for, where larger firms can apply what they have learned over the years and can create private credit funds that align with investment flows and could operate more broadly across the alternatives space. Some of these opportunities, such as real asset related credit funds and asset financing, as well as new geographies, could all represent a huge opportunity. Really we have only just scratched the surface!