Demand for yield and floating rate securities is causing money to pour into private debt funds at a potentially alarming pace. Per an article in Barron’s, the concern is that aggressive demand is creating an environment of loose lending standards (“cov-lite” loans) for a product that isn’t registered or publicly reported, which makes evaluating the health of these investments very difficult. Highlights from the article:
- “Some $104.6 billion of new high-yield loans were made in May, according to Moody’s Investors Service, topping a previous record of $91.4 billion set in January 2017, and the pre-crisis high of $81.8 billion in November 2007.”
- “Covenant-lite documentation—deals with no or very few covenants—has re-emerged and spread across the syndicated loan market. Now, 77.6% of all outstanding loans are ‘cov-lite,’ according to S&P Global.”
- “With more players in the market, the fight for deals has intensified. Preqin surveyed 94 private-debt fund managers last November, and 70% said they faced greater competition compared with the year before. Almost half said deal pricing was the top challenge, and sourcing deals the next most troubling thought. ‘Dry powder’ in private debt funds—money ready to be deployed—reached a record $235 billion in March.”
The article mentions that private debt funds have performed well over the last 10 years, with funds managing an IRR of 8.2% (compared against 8% for VC and 9.6% for private equity). Performance and demand for floating rates in a rising interest rate environment explain the sudden increase in popularity. The question is whether or not the performance will continue as terms loosen.