We believe that the secular trends of large bank disintermediation and general market volatility are likely to continue in 2016, presenting compelling investment opportunities for alternative credit providers with multifaceted investment capabilities.
Banks Head for the Exits
U.S. bank disintermediation is certainly not a new concept, as the corporate lending marketplace has evolved considerably over the last 30 years, with massive waves of banking consolidation and enhanced regulatory scrutiny. This evolution has accelerated over the last five years in the aftermath of the 2008-2009 credit crisis, and only now, after the multi-year phase-in of Dodd-Frank, Basel III and the Volcker rule, can we begin to assess the real impact of regulatory oversight.
The evolution of the relationship between borrower and creditor, in many ways, has stoked market volatility. Many banks that originated, held and made active markets in loans and bonds in conjunction with their proprietary trading efforts continue to exit large swaths of the business, directly impacting the depth and liquidity of corporate credits. We believe this illiquidity presents a significant investment opportunity for well-capitalized, thoughtful investors who can access assets across the capital structure.
Another factor, in our view, is the reduced flexibility of some credit players, who may not be able to capitalize on current opportunities. For example, hedge funds have often served as marginal buyers of illiquid credit during market turbulence; however, given recent poor performance and redemptions, many long/short hedge funds may be unable or unwilling to take on illiquidity risk associated with the purchase of some credits. More traditional competitors, including collateralized loan obligation (CLO) funds and business development companies (BDCs), are constrained by regulatory hurdles, rating agency tests and, critically, the necessity to be fully invested at all times. This could hamper their flexibility in times of market dislocation.
Opportunity for Patient Capital
The net result is an environment with the potential to reward patient capital that has the ability to participate at points of market weakness where other buyers are limited. In our view, recent market turbulence has enhanced the return potential of the secondary market, while attractive opportunities exist in the new issue market. Increased volatility could make private debt more attractive to issuers seeking certainty as to the closing of their transactions. Over $440 billion of uninvested private equity capital was raised in 2011-2014, which could feed demand for private debt to finance buyouts and lend further support to this market in 2016.
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