Credit Market and Private Debt Predictions for 2018

Market Conditions and Capital Flows

• Eurozone high yield spreads compressed to 2%, prompting historical comparisons to the 19th-century British saver's reaction to such low rates.
• Private debt markets have experienced a significant influx of capital, with approximately 75% of new fund launches this year focused on this asset class.
• The US middle market constitutes a $5.3 trillion opportunity set, generating 62 million jobs over the past 30 years compared to a 4 million job reduction in the Fortune 500.
• European banks remain over-levered (assets at €44 trillion against €20 trillion GDP) and are structurally exiting the mid-market, creating a vacuum filled by private credit providers.
• Regulatory pressure has pushed 60% of mid-market capital funding in Europe back to the banking community, though non-bank private credit is rapidly gaining share.
• Private credit funds are targeting high single-digit returns, offering a liquidity premium that public markets currently fail to provide.

Lending Terms and Covenant Structure

• Public leveraged loan markets have become predominantly "covenant-light," a trend Adam McQuade (Bearings) notes is unacceptable for their private direct lending model.
• Private credit providers are responding to public market aggression by introducing "covenant-light" products, though Nigel McIntosh argues this remains limited to specific, differentiated strategies.
• John (US perspective) warns that loans without covenants are unsustainable long-term, citing a history where "non-discerning" lenders win deals but lose wars during downturns.
• Disputes increasingly center on EBITDAR definitions and the frequency of pro-forma adjustments rather than the outright presence of covenants in private deals.
• Bearings has never executed a deal without covenants, viewing them as essential protection against insolvency events in non-syndicated, direct lending structures.
• Investors are demanding transparency on risk and fees, with Maria Stone noting a shift from "irrational exuberance" to "fundamental credit analysis" as a primary selection criterion.

Investment Strategies and Performance

• Bearings targets a 10% net return for investors in 2018, down from a 14.8% annualized gross return over the previous 12 years, citing compressed spreads.
• Private debt managers emphasize continuous capital deployment to avoid "fallow periods," contrasting their low-volatility, monthly cash-flow model with the J-curve and lumpy returns of private equity.
• Online lending (formerly peer-to-peer) portfolios are generating levered returns above 13% with unlevered returns of 8-9%, focusing on "near-prime" subprime loans where yields exceed expected defaults.
• Investors are projected to lose approximately $15 of capital for every $100 lent in the online sector, a risk mitigated by short loan durations (18–24 months) intended to clear books before a predicted recession in 18 months.
• The market currently trades at "mid-cycle pricing" for "late-cycle risk," driven by a consensus that the credit cycle will not turn due to the slow pace of quantitative easing unwinding.

Sector and Geographic Risk Analysis

• High-quality credit is concentrated in Software as a Service (SaaS) companies with high customer concentration and switching costs, while energy, retail, auto supply chains, and gaming face higher mortality risks.
• Political risks, including Brexit, the Italian election, and US trade policy, are being priced into investment models but are not causing a significant contraction in deal flow; instead, they are viewed as sources of potential dislocation and opportunity.
• Deal quality in the UK has dipped post-Brexit, prompting a strategic shift toward a broader European opportunity set, though new investments in the UK continue.
• Asian operations are restricted to "developed country risk" jurisdictions (e.g., excluding South Korea due to political landscape concerns) to ensure enforceable debt recovery.
• A significant regulatory risk in Europe is the potential for "nationalistic substance" requirements forcing asset managers to operate locally, which could fragment the pan-European asset management landscape.
• US policy wind favors the middle market, with deregulation and tax cut expectations creating a favorable environment for the sector's job creation and growth narrative.

Forward-Looking Statements

• No panelist expects the current credit cycle to end in the immediate future, citing the "glacial pace" of interest rate normalization and bank balance sheet constraints.
• Market participants anticipate continued growth in private debt allocation as pension funds and insurance companies seek yield in a low-rate European environment.
• A distinction is drawn between public market "irrationality" and private market "discipline," with the consensus that the private sector remains more robust despite a flood of new entrants.
• Panelists warn that new entrants lacking experience in distressed management and downside protection may face severe losses when the cycle inevitably turns.
• Investors are urged to perform rigorous due diligence, particularly regarding the alignment of manager incentives, transparency, and the ability to explain complex asset classes to trustees.