This research series was established six years ago to explore the factors supporting the expansion of private credit. In doing so, it has highlighted the benefits of the asset class for businesses and investors, while also making the case that private credit supports economic resilience. This year’s paper explores how the sector is still demonstrating its value to businesses and investors.
The Covid-19 coronavirus pandemic has challenged the viability of many businesses and the jobs they provide. Governments around the world have responded by introducing liquidity support and employment protection schemes to support businesses and retain the productive capacity of their economy. The primary beneficiaries of this support were borrowers typically served by traditional lenders, and those with access to the public lending markets. Borrowers unable to access public lending markets or underserved by traditional lenders often found themselves outside the scope of such support. Our research shows that the private credit sector has played a vital role supporting such businesses during this period.
Private credit managers and their investors have demonstrated their commitment to lending and expect to provide businesses with over $100 billion of new capital during 2020. This is broadly consistent with the amount invested during 2019 and our research indicates they are likely to continue lending similar amounts in 2021. There are numerous examples which illustrate how private credit is financing the real economy throughout this paper.
As well as being a lifeline for businesses seeking new finance, private credit managers have also been a dependable partner to existing borrowers. Private credit managers have worked with businesses facing stress and offered pragmatic support when this was most needed. Resizing financial commitments to reflect changed circumstances has helped stressed borrowers establish a new path towards growth.
Investors have also faced increased volatility across their equity portfolios and reduced yields in their fixed income allocations. Private credit has helped investors address these two challenges by providing diversification, acting as a hedge and offering them assets that can generate income. The ability of private credit managers to deploy new capital and protect value in their existing portfolios during the pandemic has demonstrated that the sector can perform well during a downturn.
While the future is harder than usual to predict, businesses are likely to continue facing short-term disruption during 2021 and any return to growth will require new capital in a variety of forms. At the same time, investors will continue to seek assets that can help them meet the needs of their underlying beneficiaries in a challenging market. Finally, regulatory barriers will continue to inhibit the growth of private credit outside its core markets.
While further challenges undoubtedly lie ahead, private credit has shown itself to be a valuable and resilient part of the financial system during 2020. We believe our research corroborates the view that private credit is beneficial for both borrowers and investors, and that policymakers should seek to maximise the role of private credit in the economic recovery.
Global Head of the Alternative Credit Council, AIMA
Partner, Allen & Overy
Private credit managers continue to lend: Private credit managers expect to lend over $100bn to SMEs and mid-sized businesses during 2020. This is broadly similar to their total lending volume in 2019 and shows that non-bank lenders have continued to provide finance to businesses, despite the economic downturn and disruption caused by Covid-19. Our research shows that the sector also remains optimistic about its prospects and it is likely that similar amounts of capital will be deployed during 2021.
Investor appetite for private credit remains undiminished: The disruption to the economy during 2020 has created demand among investors for assets that can generate income, provide diversification or act as a hedge during equity bear markets. Private credit is an attractive way for investors to address these requirements at a time when traditional fixed income assets are offering either minimal or negative rates. Monetary policy therefore continues to create strong incentives for investors to maintain or increase their allocation to private credit, supporting the flow of credit to parts of the economy underserved by traditional banking or public markets.
Private credit managers have demonstrated their value to borrowers: Non-bank lenders have been vital sources of finance to borrowers during 2020, particularly those who are outside the typical risk appetite of banks or were unable to access government liquidity schemes. The ability of private credit managers to provide flexible capital solutions has come to the fore during the pandemic. Our data indicates that there is a general trend among private credit managers favouring a pragmatic approach towards forbearance when required. This is being applied in a targeted manner to reflect individual borrower’s circumstances.
Flexibility is a prized asset: As borrowers’ finance needs and economic circumstances become more mutable, their position on the spectrum between par and distressed lending opportunities will fluctuate. Investors and private credit managers are positioning themselves to adapt to the greater range of lending opportunities they anticipate in 2021. Performing loans in the SME and mid-market are expected to be the biggest opportunity to deploy capital in 2021, with the
sector also anticipating greater investment in liquidity/bridge finance or special situations lending.
Not all private credit managers are created equally: The impact of Covid-19 has been uneven across different regions and sectors within the economy, but it has also highlighted differences in deal origination, documentation standards and risk management capabilities within the sector. The pandemic has placed a magnifying glass on these differences, with investors seeking greater assurances on risk management and performance reporting. Existing exposure to cyclical or Covid-19-affected sectors is also affecting a private credit manager’s ability to take advantage of investment opportunities during the current downturn. These factors are likely to drive dispersion of performance within the sector during 2020 and 2021.
Raising capital to support the recovery: Private credit managers continued to raise capital effectively during 2020, with newer funds largely being an evolution of existing strategies. Our data indicates that respondents expect this momentum to continue and investor attitudes will remain broadly positive towards private credit. 88% of firms are planning to continue raising capital for existing strategies and 98% of respondents plan to raise capital in some form next year. 89% of respondents expect more allocations to distressed debt strategies. Strategies focussing on infrastructure debt (52%), speciality finance (50%) and SMEs (45%) were also viewed very favourably by respondents. By region, respondents were most favourable towards Europe, the US and APAC (excl. China and India) focussed strategies.
Financing the Economy 2020 is based on data from several sources. The Alternative Credit Council (ACC) and Allen & Overy LLP (A&O) conducted a survey of private credit managers. 49 private credit managers responded to the survey; collectively they manage an estimated $431bn in private credit investments, across a broad cross-section of jurisdictions and strategies. The survey data was then explored by the ACC and A&O in a series of one-on-one interviews. Private credit managers were also invited to submit case studies of how their firms are contributing to the real economy, which you can find throughout this paper.
Our data shows that private credit providers continued to be a vital source of finance to borrowers during 2020, especially those who required flexible capital solutions and are outside the typical risk appetite of banks. The sector is on track to invest more than $100bn during 2020 and set to do the same in 2021. Private credit managers have also stepped in to support borrowers facing stress due to the pandemic.
While few anticipated the scale of disruption that has characterised the economy this year, the sector has performed well and demonstrated resilience in the face of significant challenges. It has also continued to offer a valuable alternative to asset allocators seeking to maintain a balanced portfolio and meet their investment needs.
Looking ahead, it is encouraging to see that capital raising for private credit strategies has not slowed down. Investors continue to recognise the attractive qualities
of the asset class and its ability to generate income, provide diversification or serve as a hedge during equity bear markets.
Our data also highlighted that the impact of 2020’s economic disruption has not been evenly felt across the sector. The pandemic is likely to have magnified existing
differences between managers on origination processes, deal structuring and risk management. Some dispersion of performance among managers is therefore to be expected during 2020 and in 2021.
The ACC’s Financing the Economy research series has helped support dialogue and collaboration between private credit managers, borrowers, investors and policymakers. This year’s edition has once again highlighted the need for the ongoing collection and distribution of data to support an evidence-based discussion on its future.