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We might be worried about inflation and recession after the pandemic, but the equity sector has remained buoyant. Private equity (PE) big-ticket deals registered historic highs in 2021 as the US saw more than $1.2 trillion in private equity transactions. If anything, the burst of liquidity with trillions pumped into the economy through monetary stimulus from central banks from March 2020 to check global slowdowns encouraged the outrageous numbers of acquisitions and exits. 2022 could well prove to be even more significant for the sector.
Increasingly, private equity firms are choosing to bypass banks altogether in favor of direct loans or borrowing money from each other. Bain’s 2022 Global Private Equity Report found that the record set by private equity in 2021 stood at securing $1.8 trillion in buyout capital. Deal sizes have grown to billions in PE mega funds from mere millions a couple of years back. PE firms are now looking to get into big leveraged buyouts — once the sole domain of large Wall Street banks — through direct loans. With returns from PE surging ahead of other asset classes and growing popularity among pension funds and wealthy investors, it is only a matter before private equity becomes mainstream in asset classes. Regulations and prevailing attitudes toward private equity are also likely to change significantly.
Related: A Beginner’s Guide to Private Equity
Direct lending is eating away at the syndicated loan market pie
The regulatory changes following the 2008 financial crisis had already forced many banks to move away from Leveraged Buyout lending. Historically, the main problem for companies trying to secure bank financing has been the slow processes involved. Given the relatively large number of participants involved in securing such big-ticket loans and the fact that they could only be guaranteed in multiple tranches (senior debt, credit fund, public markets) in the syndicated loan market, the process ended up being long and drawn out. This also made it harder for companies to keep deals quiet until they were ready to announce them.
In contrast, direct lending funds are much easier to secure through unitranche financing, and the process can be shorter by as much as a month or more. Private equity will likely become a much larger capital provider, meaning massive growth.
Massive impact on banks; Taxing norms may change
Leveraged finance, responsible for the lion’s share of lucrative investment fees earned by Wall Street bankers from arranging mega deals, could very well see a downturn with direct lenders joining the fray. The latter may also offer better leverage to borrowers as it has more leeway than the banks’ regulatory manacles. Some, for instance, are doing away with performance tests of borrowers to compete with lighter covenants offered by banks. It may no longer be enough for banks to charge lower yields to attract borrowers.
As large amounts of capital switch routes from banks to private equity funds, it will likely attract more scrutiny and taxation. Direct lenders currently enjoy comparatively less regulatory oversight, but there will likely be a shift to taxing private equity funds.
Private equity has traditionally been a game for accredited investors with a lot of money. But with more and more private equity companies going public, it is now possible for the average citizen to potentially get in on the action for the first time.
With fixed income yields nearing zero, the pools of capital are turning toward private lending for higher yields. Any investor can now invest in the company’s future if not directly participate in the funds under management.
With deal scales soaring, private credit is becoming a product in its own right vis-à-vis the syndicated loan market. The future is uncharted, but if private equity continues to finance multi-billion mega deals as it has in the past, it is bound to get closer scrutiny from regulators and investors alike.
As public participation widens, private equity firms would also be incumbent to ensure transparency and clear processes. This could, in turn, affect whether or not regulations about private equity change. Those involved in private equity are already aware and using lobbying and other structural actions to deal with likely major shifts on the horizon.