Private debt managers are having a tough time raising capital amid the coronavirus pandemic.
Fundraising for private debt plummeted in the first quarter to $14 billion, the lowest level since the first three months of 2016, according to a Preqin report Wednesday. That’s a 62 percent drop from the $37 billion raised during the fourth quarter.
“This comes as the pandemic halts global travel and changes working lives, postponing fundraising schedules and canceling investor meetings,” Preqin said in the report. “Despite the economic turmoil, the number of private debt funds in market has continued to grow to a new record level.”
Investor demand for private debt had soared over the past decade, leading to a proliferation of funds that lend directly to small and mid-sized companies controlled by buyout firms. With the pandemic shutting down economic activity across sectors, investors now are increasingly worried that highly leveraged borrowers will struggle to meet their debt obligations.
Moody’s Investors Service said in an April 3 report it expects a big spike in defaults “as the coronavirus pandemic unleashes economic and financial turmoil around the world.” Buyout firms own a significant portion of vulnerable borrowers with low corporate credit ratings, Moody’s has warned, as they fund the purchase of them in part by loading their balance sheets with debt.
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The number of private debt funds seeking capital has been rising over the years, creating the most crowded fundraising market ever — just as investors become wary of risky corporate credit. A total 457 private debt funds are now seeking a record $201 billion from investors, Preqin said, estimating that 47 percent of the targeted capital is for direct lending strategies.
“Amid global economic uncertainty, investors in private debt are adopting a cautious approach to the next 12 months,” Preqin said in the report. Seventy-three percent of investor mandates for private debt funds in the first quarter are for commitments to a single fund, up from 62 percent a year earlier, according to the report.
Before the novel coronavirus recession, some industry experts suggested the expansion of private debt would provide a cushion in a downturn. After all, fund managers’ so-called dry powder, or uninvested capital, was hefty last year.
In June, direct lending funds had about $105 billion of dry powder, while distressed debt funds were sitting on about $75 billon, according to Preqin. Mezzanine fund managers had the third-highest level of uninvested capital at $56 billion, while special situation funds had $47 billion.
Moreover, private debt funds often lend to companies backed by private equity firms, an industry with its own massive stockpile of dry powder. Private equity firms were sitting on about $1.5 trillion of uninvested capital in June, compared to $674 billion at the end of 2009, according to Preqin.
That dry powder could be used to help companies they’ve already saddled with buyout debt, or for new deals.