Why companies might consider the private debt market

Contributors: Shane Dunn, Walid Safri, Barkin Sayiner, Roger Leslie, Michael Campbell

What is private debt and why is it so popular?

Private debt has been around for decades as an alternative source of capital to traditional lending offered by banks. It wasn’t until after the financial crisis of 2008 that private debt grew in popularity as traditional banks became more regulated, focused on disciplined lending criteria and stepping back from providing capital. In fact, back in 2000, the private debt market was merely US$43 billion. At June 2019, it was estimated to be a US$800 billion market and on track to achieve a market size of US$1 trillion in the not too distant future.

Another big contributor to the growing private debt market is the overall low interest rate environment experienced over the past decade, as investors ranging from large institutional players, to family offices to investors looking for a better yields in their investment portfolio became attracted to the private debt market.

As COVID has affected the global economy in a negative way, many traditional banks have pulled back capital as concerns of default and higher risk plague their portfolios. This has presented an opportunity for the private debt market to step up and fill in the gap.

Who funds private debt?

The most active investors in the private debt market are pension funds, foundations, endowments and insurance companies, followed by family offices, fund of fund managers and others. For example, in 2018 the Canada Pension Plan allocated 11% to the Private Debt Market (source 2018 CPPIB Annual report).

Private debt to asset classes

Private debt is a general term and can be structured in many forms, ranging from direct senior secured debt all the way to junior capital like subordinated debt and mezzanine debt.

Leverage multiples

Not surprisingly, the leverage multiples are down by about 0.9x as a function of total debt to EBITDA due to COVID-19 from all-time highs of 6.0x in 2019. Despite the pullback in leverage multiples, overall leverage in the first half of 2020 remains higher than after the financial crisis. The main difference with COVID is the decline in second lien, unsecured and subordinated debt instruments, and a bias to senior secured or first lien debt.

As traditional lenders fall within first lien debt availability, the private debt market typically fills the gap with a fulsome debt solution which covers first lien debt to mezzanine debt.

Why should companies consider private debt?

Private debt has gained traction and attention since it offers an alternative to traditional debt sources that are governed by regulators, conservative risk appetite and structured covenants.

Although the cost of capital and fees for underwriting the private debt instrument(s) are more expensive, companies see the cost as a trade-off, obtaining an innovative way of borrowing capital outside of traditional banks.