While fundraising and deal activity in the $975 billion private debt market is ramping back up, the industry is still “not out of the woods” of the pandemic, according to Walter Owens, chief executive officer of Varagon Capital Partners.
“We have to be very careful of complacency, because complacency is what gets you into trouble,” Owens said in an interview. “We’re hopeful that the economy fully recovers, but we’re certainly not depending on a full economic recovery when we’re underwriting deals today.”
The asset class has largely recovered from the pandemic-fueled selloff in global financial markets last year as economies reopen and wider swaths of the U.S. population become vaccinated. Yet concerns remain with unemployment still stubbornly high, and uncertainty hanging over some industries that were hit hard during Covid-19.
The firm sees opportunities in more resistant sectors like business services, healthcare and software services, according to Owens. “Most of those businesses came through 2020 in really good shape,” he said.
Demand for the debt, which can offer higher returns than elsewhere in credit, is also helping to drive a pick up in deal activity. And firms are currently looking to raise a record $301.4 billion for 586 vehicles, according to London-based research firm Preqin Ltd.
“In terms of investor appetite for this asset class, it’s increasing,” Owens said. “And I only think the pandemic performance across the direct lending space is going to make people even more comfortable with a private asset class like direct lending.”
Many private credit shops lend to sponsor-backed businesses. During the pandemic, some of those private equity owners took extraordinary measures to help keep companies in their portfolios afloat, including supplying them with cash to help them weather economic shutdowns induced by the outbreak.
“They stepped up, they supported their portfolio companies through unprecedented dislocation,” said Kevin Marchetti, chief risk officer at Varagon. “They shored up balance sheets. They provided liquidity. They worked very well with lenders. The support was there.”
But as businesses recover, sponsors may now seek to clinch deal terms that are more in their favor. Half of the private equity firms in a recent industry survey from Katten Muchin Rosenman said they expect to be more aggressive in talks with non-bank lenders versus the second half of 2020. For Marchetti, however, that scenario hasn’t materialized yet.
“I don’t think we’ve seen anything change,” he said. “I think we’ve seen even more support come in.”