According to the Chinese horoscope, 2021 is the year of the Ox. In the Chinese culture, the Ox is an animal traditionally used in agriculture to plough fields, most commonly rice fields, given his ability of moving through swamps comfortably. As such, both culturally and astrologically, the Ox represents prosperity, diligence, perseverance and wealth. Throughout 2021, the private debt industry is hopefully going to display some of these traits, and very much like the Ox, plough through the COVID-19 pandemic and exhibit perseverance, diligence, and most importantly, wealth.
Following the Great Financial Crisis (GFC) of 2008, the financial services sector – most notably, the banking sector – faced a wave of enhanced regulatory requirements and supervisory expectations in an attempt to drive de-risking and restore trust. As a direct result of the enhanced rules around risk- based capital requirements, banks were forced to reduce lending due to capital constraints. This allowed private debt firms, amongst other alternative lenders, to capitalise on the void left by banks. As a result of this, private debt has been on the constant rise since 2009, becoming an asset class which is not only accessible, but that also provides stable returns (PDI, 2021).
As shown in Figure 1, COVID-19 in the UK has caused the highest drop in GDP since the war of Spanish Succession over 300 years ago (close to a 10% fall). A similar impact has been felt all around Europe: Spain experienced an 11% fall, a worse fall than after the civil war, Italy fell by 8.8% and France by 8.3%. However, these drastic falls in GDP still haven’t been felt as strongly and as immediately as during the GFC. This is mainly due to the unprecedented fiscal stimulus and government aids that have been put in place in order to avoid a drastic recession.
Yet, in an attempt to soften the financial crisis, these mainly debt-based rescue packages have zombified and frozen the economy, quite often delaying the inevitable. Once the fiscal stimulus begins to be gradually withdrawn, the economy will thaw and the veil covering the real damage will be lifted, displaying a once in a lifetime scenario. Not much time is left until this begins and it is now that the aid is beginning to slow that the private debt sector has the opportunity to display its full potential at a European level.
The world before the pandemic
In order to adequately assess the impact of the pandemic, it is important to revisit what the world looked like before COVID-19 and where we were heading to. Pre-COVID, most of the developed world enjoyed the longest benign credit cycle in the history of modern finance, mostly funded by an expanding debt bubble. In 2019, the US credit market was approximately 11 years into the benign credit cycle, which began in the second quarter of 2009. The table below shows the four main indicators of a benign credit cycle which Prof Altman takes into account.
This benign credit cycle allowed capital to be a cheap and accessible commodity. As a result, debt levels in 2019 reached their highest level since the 90s. Figure 2 (see below) shows the growth of indebtedness across governments, non-financial corporates, the financial and households between 1997 and 2019. We can see that corporate debt increased to almost 95% of global GDP, up from just 64% over 20 years ago. The same trend can be seen regarding government debt which is at 88% of global GDP, a figure we believe has now increased as a result of government spending and the refinancing of debt throughout 2020.