A firm setting up to target private credit argues this so-called "shadow" sector deserves more visibility and is getting more attention from end-investors such as wealth managers.

The world of private credit might sometimes be referred to, somewhat misleadingly, as part of the “shadow banking” sector (there is nothing particularly obscure about it) but with traditional fixed income markets facing continued headwinds, investors hungry for yield and businesses in need of credit, attention keeps growing.

A new player raising capital and talking to entities such as family offices, among others, is Firebreak Capital, which in June announced plans to fully launch later this year. The announcement came from former Goldman Sachs managers Rob Allard and Jonathan Egol. The business says it is a dedicated private debt hedge fund focusing on the “rich opportunity set wrought by financial regulatory reform and bank capital requirements”.

Allard, who had been at Goldman Sachs since 2008, has already gone into print about how “shadow banking is coming out of the shadows”; he argues the time is ripe to tap the market. He spoke to Family Wealth Report recently.

“Banks now have trouble lending in anything that is no longer plain vanilla, simple and not 100 per cent transparent. Structured finance is complex and not fully transparent and therefore has become increasingly prohibitive for banks,” Allard said.

“We see a situation of decreasing supply and increasing demand for financing – at least in terms of the specific financing required,” he continued. “We have identified forms of activity that banks are temporarily or permanently retreating from,” he said.

Firebreak is looking at the kind of opportunities arising in the wholesale side of the lending world.

Allard and fellow Firebreak leader Jonathan Egol both bring over their experience from Goldmans, where they were managing directors. Allard was head of structured product origination and distribution and Egol was head of the mortgage CDO, correlation and derivatives trading business in addition to sitting on GS Bank risk and counterparty credit risk committees.

Firebreak’s founders say the weather is set fair for private credit. Preqin, the research firm, said in a survey of investors in February that 57 per cent of investors intend to increase their allocation to private debt in the following 12 months, with 65 per cent looking to increase their allocation over the longer term.

That organization has also said, in a report issued in November last year (Preqin Special Report: Private Debt): “As a financing option for middle market businesses, the flexibility offered by non-bank lenders is a welcome alternative to the traditional banking system which, through the ongoing process of disintermediation, has had to de-leverage. The flexibility gained when working with a debt provider versus a bank can drastically speed up the underwriting and financing processes for a mid-market borrower, as well as offer more flexible loan terms due to the motivation of fund managers ready to deploy accrued investment capital.”

There appears to be an element of oscillation in terms of internal rates of return when measuring performance of private debt, Preqin said last November: “The median net IRR for private debt strategies peaked for vintage 2001 funds, reaching a high of 17.3 per cent. However, for vintage 2002 funds and onwards, the median fell below 10 per cent and then flattened out, before moving steadily along when it reached a further peak of 16.7 per cent for vintage 2009 funds, and then falls again for vintage 2010 funds.”

Institutional investor demand for private debt hedge funds increased for the third quarter in a row, with six new mandates so far, according to data compiled by Bloomberg recently. The six new private debt searches since April 1 correspond to one-sixth of all hedge fund searches this quarter, a ratio of 16 per cent, the second-highest since Bloomberg began tracking the data.

Firebreak is not the only firm operating in such a space; FWR interviewed BroadRiver Asset Management, another US-based organisation (to view this item, see here).

Visibility

Private debt as an asset class is gaining more visibility within fixed income; this means that investors have more of an idea of what asset “bucket” to put it in, Allard said.

What sort of investor is Firebreak approaching?

“Our initial focus [for investors to back the business] is family offices, endowments and professional seeders,” Allard said. “We are now starting to get a bit more inbound interest because of there being more coverage of private debt. For family offices, the initial attraction has been that traditional fixed income strategies haven performed particularly well and the strategy offers interesting co-investment opportunities,” he said.

Firebreak’s private debt strategy can be robust during shifts in the interest rate/economic cycle due to the underlying assets being indexed to Libor (therefore rising rates are positive) and the asset-backed nature and structural protections built into these customized facilities.

He said Firebreak’s private debt strategy should have higher levels of asset protection and hence limited downside given investments are secured by assets and contractual cash-flows with triggers to divert cash-flow if performance drops below agreed parameters.

Allard said he has already invested a lot of time and effort in creating an infrastructure for capturing deals and finding out about them, so that when deals come to light, the firm can talk to clients, such as family offices, and ask how they want to invest, such as through co-investments on specific deals, etc. His firm thinks that a differentiated and robust sourcing platform allows it to differentiate itself versus other managers and that will drive out-performance. With education of clients, the situation has gone beyond explaining why these markets exist as to the specific strategies within private debt, he said.

The US market is less dependent on bank debt than in Europe, and in Europe, up to around 80 per cent of financing for firms comes from banks, which means if there is any diversification, the opportunities for private debt in Europe to grow are huge, he said.

Worldwide, rules under the Basel regime and other regulations are squeezing banks’ balance sheets and driving innovation in non-bank financing. Asia is not yet seeing much of this trend although the Australia market, which is a way to play into China, is one where such developments are taking place, Allard added.