The European sovereign debt crisis has opened up new interesting opportunities in the private credit space. As banks seek to deleverage their balance sheets to raise core capital ratios, private fund managers have a chance to step in and buy distressed debt on assets at attractive valuations.
Corporate distressed opportunities are also arising, as those companies with credit facilities approaching maturity are experiencing trouble refinancing. This is especially true for those companies in the small to mid cap space.
“In Europe we are in the same place we were in the US post Lehman,” says Rhian Horgan, international head of alternatives at JP Morgan Private Bank. “In the first quarter of 2009, many assets were sold by forced sellers, as people had liquidity issues rather than issues with the underlying assets. That really gave distressed investors great opportunities in private credit.”
The focus is on managers that have the ability to go in and restructure the companies and put in a proper capital structure that could withstand the continuous volatility in Europe. These debt investors are typically buying in at a much cheaper valuation on these ‘distressed for control’ opportunities, she explains.
The real estate market also continues to have attractive distressed pricing, as a considerable amount of debt is coming up for maturity over the next few years. These maturities are likely to lead to a significant amount of restructuring. In 2012-2014, it is estimated $135bn (€102bn) worth of commercial mortgage backed securities will be maturing in the US, while only $30bn was issued in the whole of 2011.
Compared to private equity, the private credit market is a newer concept. The market has been dominated by bank lending for a very long time, while the concept of private lenders has really only emerged post 2008. “We are seeing more and more opportunities in the private credit space and I would expect it to become a growing part of the portfolio as we continue to see deleveraging,” explains Ms Horgan.
“In the private credit market in Europe and in the US today, you can earn 7 to 8 per cent premium over public credit, by being a lender that is terming out financing. The reality is that companies will pay a premium for certainty.”
While private equity managers aim to generate 20 per cent plus return, typically private credit managers target 15 to 20 per cent returns but today these are targeting 20 per cent plus return too. Private credit managers are able to buy into real estate at prices where they will still be protected, even if real estate fell 50 per cent from sales levels or even if default rates on consumer loans double, says Ms Horgan.
“These returns are very attractive, particularly in a low growth environment, where investors are starved of yield and public equity and credit generate modest returns.”
But capital fund raising is also being impacted by the global debt crisis and risk appetite is down.
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“New money is significantly harder to raise, both institutionally and from private clients, in the current environment,” says David Bailin, global head of managed investments for Citi Private Bank. Partly, this is due to the low returns generated by funds in most recent vintage years, to the crisis itself and to clients being more conservative and holding cash, he says. “Our clients tend to build positions over time and collect private equity exposure. But in general right now, capital raising is probably three quarters of the level it was 18 months ago.”
However, the amount of money raised in the years before the 2008 crisis was so large that there is an overabundance of capital on the sidelines. According to information provider Preqin, the amount of capital in all private equity fund types raised globally in the three years between 2009 and 2011 was $1,896bn versus $862.5bn raised in the three years between 2006 to 2008 (see Fig 1).
“It is a bit of clouded picture, but if you look ahead at 2014, the funds that represent this large pool of capital will stop operating in a virtual sense,” says Mr Bailin. “That could be a time when there will be both a large amount of opportunity and prices will be diminishing. For a buyer, this will be a great combo that will take place in several years from now.”
Routes into private equity
There are three main routes which high net worth individuals or families can take to invest in private equity. The first one is direct access, by investing directly into a private equity fund, and becoming a Limited Partner in that fund.
However, as minimums thresholds to get into funds can be as high as $25m, medium to high net worth investors will generally need to go through a fund of funds route, in order to get the appropriate diversification.
