Loan defaults in the USA, price declines in listed private debt vehicles and new risks in the software sector: For several months now, business media have been increasingly reporting on risks and possible distortions in the private debt market. In doing so, they raise important questions about the stability and transparency of the asset class. Dr. Markus Faulhaber, Senior Strategic Advisor of the BF Group, and Eugenio Sangermano, Managing Director of BF.capital, plead for a differentiated view of private debt.
“The current reporting, which is often negative, is in many cases too undifferentiated and can convey a distorted picture of the asset class,” says Eugenio Sangermano. “The central problem is often not the quality of the underlying loan structures, the borrowers or the loan documentation. Rather, tensions arise where illiquid assets in comparatively liquid fund structures meet investors with a shorter investment horizon. In such constellations, short-term market movements and investor-driven behavior can create a dynamic that is more reminiscent of stock markets than of the institutionally shaped investment segment in the private debt market, which is designed for stability and long-term investments over many market cycles,” adds Dr. Markus Faulhaber.
“Many of the criticisms currently being discussed primarily concern specific structures of individual market segments, such as listed business development companies in the USA, and can only be transferred to a limited extent to fund structures, which are typically included in the portfolios of European investors,” says Eugenio Sangermano. As a current example, he cites the development at BlackRock TCP Capital Corp., which recently reported a significant decline in net asset value and limited payouts. “The case shows above all structural peculiarities of the BDC model: higher leverage at fund level, exchange-traded tradability with correspondingly volatile price reactions, and a greater dependence on stable current income for dividend financing. Traditional private debt funds have a much more conservative structure here – often without leverage at fund level, with long-term capital tied up and a distribution policy based on stable interest and repayment flows,” says Eugenio Sangermano.
Artificial Intelligence: Danger or Rather Opportunity for Private Debt?
In Eugenio Sanderuro’s view, the current discussion about risks in the technology and software sector is also focused too much on private debt: “In fact, private equity investors are much more affected by possible value corrections due to the valuation dependence of their portfolios. Private debt funds, on the other hand, predominantly grant shorter-term loans with clear covenants and senior position in the capital structure – factors that make repayment more likely in many cases.”
In addition, the warning of possible disruptive effects of new AI applications refers to sectoral concentration risks and less to a structural weakness of the asset class. “Technological transformation can also open up new financing opportunities. Companies are increasingly investing in automation, data infrastructure and AI integration, which in turn generates additional capital requirements. For private debt managers with strong industry expertise, the ability to assess technological disruption in a differentiated way can therefore become a source of relative competitive advantage rather than a structural risk for the asset class as a whole,” says Dr. Markus Faulhaber.
Is there a risk of bubbles in private debt?
In addition, critical voices warning of overheating tendencies and potential systemic risks of private debt have increased in recent months. Eugenio Sangermano comments: “Basically, the growth of private debt is primarily a consequence of tighter banking regulation after the financial crisis. While banks have withdrawn from parts of the mid-market and sub-investment grade lending business, private debt funds are closing this financing gap. At the same time, the industry has become much more transparent and regulated in recent years, for example through frameworks such as AIFMD II or ELTIF 2.0.”
From Dr. Markus Faulhaber’s point of view, the central risk dimension lies less in a systemic risk of the asset class than in sound analysis, disciplined structuring and active management: “Private debt requires strong sector know-how, stringent underwriting discipline and active portfolio management. Strong origination, experienced teams and a careful covenant structure go a long way in making portfolios robust and resilient.”
Private debt is an asset class that offers investors attractive returns for complexity, illiquidity and the high level of analysis and structuring required. Typically, these are individually structured and secured loans that have historically lower default rates and higher recovery rates than corporate bonds of comparable credit quality. This makes it all the more important to take a differentiated view of the different market segments and fund structures within the asset class.
