Private Debt Boom Stokes Zeal, and Some Worry, at Milken Summit

(Bloomberg) -- These are boom times for investment firms that make direct loans to small and mid-sized companies. The promise of higher returns and better underwriting standards than those available in the public markets have helped drive hundreds of billions of dollars into private debt funds.

It made for a hot topic this week as the titans of finance gathered in Beverly Hills, California, for the annual Milken Institute Global Conference. Executives at firms from Oak Hill Advisors to Barings still see plenty more opportunities. But some flagged concern that the market -- on pace to reach $1 trillion next year -- will overheat. Here’s a snapshot of what was said during panels and on the sidelines:

Glenn August, Oak Hill Advisors LP

“Private credit has gained a lot of interest over the last couple of years, in particular, and will continue to grow in interest,” the Oak Hill chief executive officer said during a panel on Tuesday. That’s because it offers the ability, on a relative-value basis, “to make an 8 to 12 percent unlevered-type return and have more downside protection in credit versus a private equity portfolio.”

Terry Harris, Barings

“Leverage is more conservative for loans to middle-market companies, which means bigger equity checks and lower loan-to-value as well,” Harris, head of portfolio management for Barings’ global private finance group, said in an interview Tuesday. Creditor protections are also stronger in such deals he said. “We do have financial covenants in every senior deal that we do and that gives us a seat at the table before there is a payment default.”

“We don’t really see banks coming back into that market,” Harris said.

Greg Lippmann, LibreMax Capital

“My view about a lot of private debt is that people love it because it is par -- until it is not par,” the LibreMax co-founder and chief investment officer said on a panel Tuesday. “If you believe that all debts are repaid, not having to worry about the timing and pricing is great.” But, he said, “we feel the Goldilocks era that we are in now -- and for the last ten years -- is going to end with either higher interest rates or a recession.”

“What we have done in private credit is we have shortened up our duration a lot. Most of our private credit is one to two years,” Lippmann said. “The key is really knowing the liquidity of your funds.”

Justin Slatky, Shenkman Capital Management

“Private credit tends to be smaller companies and they have less levers when there becomes an issue,” Slatky, Shenkman’s co-CIO, said Tuesday on a panel. “When you are in a 10-year bull market and you lever private debt a couple of times it feels like a great investment and will continue to feel like a great investment as long as there are no hiccups in the economy. But as you get any stress in the system, these middle-size companies they usually have a much harder time reacting.”

“You have to make sure that you really have an investment thesis that enables you to play through a longer period of time. In the public markets you are able to make a decision every day and mark to market and change how you view how you’re investing based upon the new information that we have,” he said. “What I worry about is so much private debt money going in because you can’t see what the levels are, and if you get hiccups that could be a very different story.”

David Solomon, Goldman Sachs

“When you get out of the regulated institutions and into some of the shadow banking markets there’s been a lot of capital that’s moved in that direction,” the Goldman CEO said Monday in an interview with Bloomberg Television. “There’s less transparency around that activity. I don’t think it’s necessarily systemic at the moment, but it’s an area to watch.”

“Some of the capital in that space is actually longer-dated capital. So it’s not money that can run away very quickly. But as those shadow credit markets grow that will be something to watch and something to monitor. Over time, finding ways to have a better understanding and more transparency as those markets grow will be important to the construct of credit markets.”

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