Key lessons from the 2009-2010 financial crisis have not been learned, according to private lending specialist Old Hill Partners, Inc. in its latest market commentary.
Covenant-light lending now makes up two-thirds of all new leveraged loans, and underwriting standards have fallen victim – again – to the incessant reach for yield, notes Old Hill. Meanwhile, the ratio of non-financial corporate debt to underlying assets has eclipsed 2008 levels, and the risk-reward relationship in corporate investment grade debt has become among the most unpalatable in history.
One difference to the pre-crisis environment, according to Old Hill, is a growing lack of market liquidity in the traded credit markets, where regulatory changes have forced many financial institutions to shutter prop desks and exit market-making activity.
Concurrently, Old Hill points out, resurgent use of derivatives mask an underlying deterioration in market depth, while billions have been poured into fixed-income exchange-traded funds (ETFs) without regard to liquidity of the underlying credit securities on which they’re based.
As an active participant in the private lending space, Old Hill notes that although private credit transactions are also not very liquid, investors are compensated for the illiquidity through higher yields.
“There is the perception that private lending strategies such as ours generate above-average yield partly because of the increased risk versus public debt,” notes John Howe, CEO of Old Hill Partners. “But this is not entirely correct. We have seen numerous cases where private debt transactions, with similar structures and risk profiles to their public equivalents, have excess yield. This is partly attributed to illiquidity, but the supposed liquidity in the traded credit markets may not be there when investors need it the most.”
Howe further notes that as Federal Reserve policy changes approach, the one-size-fits-all, blind-faith approach of most traded credit vehicles may not perform as expected, highlighting the advantages of private lending transactions such as those structured by Old Hill Partners.
Darien, CT-based Old Hill Partners Inc., is an SEC-registered investment adviser with significant experience in asset-backed lending and alternative investment management. The firm offers customized lending products and services to middle market clients seeking creative funding structures for growth initiatives. Founded by John C. Howe in 1996, Old Hill has funded approximately $600 million in asset-backed lending transactions, and has approximately $500 million in assets.