As Investors Indulge in Blackstone Calls “Golden Moments” of Private Credit, Some investors are watching loan portfolios for signs of stress.
But what are the signs?
In recent years, private credit providers have Actively engaged in financing transactions It may have been done in the syndicated loan market or bond market in the past. The pandemic has further accelerated this trend.
Borrowers of private credit loans are now feeling an increasing burden due to rising interest rates. Loans made in 2018-2019 are of particular interest because credit market conditions were strong at the time, market experts said.
In the case of syndicated loans, rating downgrades often prove borrower decline. However, private credit loans are usually not rated.
Another difference between the two markets is the number of lenders. Most private credit loans are held by a small number of lenders, but syndicated loans may be held by dozens or up to 200 lenders. Information about increased stress often surfaces from large lender groups.
‘Notable and concerned’
One focus in recent quarters has been the fixed charge coverage ratio, a measure of a company’s ability to repay interest and debt from free cash flow.some borrowers Switched to mezzanine finance To alleviate stress in an environment where it is difficult to raise new borrowings or make new loans without resetting existing loan terms.
Advisory firm Lincoln International said earlier this month that 45% of businesses could record a “noticeable and alarming” decline in fixed-rate coverage as of the first quarter, according to its own private market database. announced (estimated basic interest rate of 5.5%). Lincoln’s database includes more than 4,750 of his portfolio companies owned by more than 145 sponsors.
HPS and Barings are reportedly hiring to bolster their internal training teams in anticipation of an upturn in the credit cycle, according to Bloomberg news reports, while Blackstone and Bain Capital last year hired restructuring specialists. It is said that we are looking for
“Spreads are widening, but higher default rates are likely to reduce some of the benefits as well,” said Michael Haynes, head of private credit at Beach Point Capital Management. Stated.
One of the signs of stress is unpaid loans in the business development firm’s investment portfolio, which points to doubts about whether principal or interest will be collected in full. In many cases, this is the first time that the stress in directly originated loans has been publicly acknowledged.
Another sign of tension may increase PIK interest on existing loans. Lenders may allow cash interest on loans to be switched to physical interest payments, a trend revealed in some public reports of his BDC, a publicly traded entity of reportable private credit providers. It’s becoming
Morningstar LSTA US Leveraged Loan Index Default Rates Up to 1.60% at the end of Mayhit a two-year high on an issuer count basis after three bankruptcy filings were recorded in a single business day.
Some say defaults in the syndicated loan market could be a proxy for private credit defaults. The trends are moving in tandem, at least for now.
under the surface
Another measure of defaults, especially private credit loans, the Proskauer Private Credit Default Index, which tracks defaults on senior collateralized loans and unitranche loans, is four quarterly, according to law firm Proskauer Rhodes. It continued to rise, reaching 2.15% in the first quarter.
The Cliffwater Direct Lending Index, a benchmark of directly originated mid-market loans, returned 2.69% in the first quarter, weighed by 0.25% in realized losses, the highest in more than two years.
Behind the scenes, there may be more stress in private credit loans that will probably never surface for investors.
In private credit, a single or a few lenders have a toolbox of measures that can reduce stress for borrower companies facing challenges. A recent survey by investment bank Carl Marks Advisors found that 22% of alternative financial institutions are “more flexible and cooperative” when working with difficult borrowers, while alternative financial institutions are more proactive. It turned out that 15% of respondents believed that
This is one of the positions that private credit providers have long used when discussing asset class benefits. A single private credit lender may have multiple loans to a particular private equity firm, so both lenders and private equity sponsors have incentives to find solutions. Some borrowers in distress may have been given wide discretion by their lenders to deal with their challenges.
“Not Enough”
CIBT Global is an example of a loan issuer whose problems became apparent after the debt was rated. The company offers travel visa and passport services, but its business collapsed due to pandemic-era travel restrictions. Despite their efforts, CIBT ran into even more trouble.
Kohlberg & Company acquired the company in 2017 through debt financing by Antares, Goldman Sachs, Jefferies and Owl Rock.
In the second half of 2020, Owl Rock transitioned some of its borrowers’ second lien loans to interest-free, indicating that the loans no longer paid cash interest. The company continued to struggle. In August of the same year, the second lien loan was downgraded to D by S&P Global Ratings.
The rating move was driven by distress-motivated actions tantamount to default, including PIK interest on second-tier bonds, partial PIK interest on bonds, covenant easing, and Revolver’s maturity extension.
Nevertheless, S&P Global Ratings announced that the company’s leverage will exceed 30x in 2022. This level was helped by the 2021 credit agreement amendment, which will shift most of the quarterly first lien interest payments to PIK. Additionally, private equity sponsors provided equity backing in 2020 and 2021, according to S&P Global Ratings.
Despite this, liquidity “was not good enough,” S&P said. The company said its travel services division, which accounted for 80% of its total revenue at the time, had only recovered to about 37% of its 2019 level.
Its efforts fell short in the face of negative trends in the industry. In early June, S&P Global Ratings once again downgraded the company to selective default (SD), with first and second lien ratings following the maturity of first and second lien loans and a modification transaction to extend PIK payments. Downgraded the second-tier line of credit to D.
winner and loser
Many investors and lenders are aware that defaults and credit impairments are expected to increase in the coming quarters as the impact of macroeconomic pressures mounts.
“The second half of the year is likely to be particularly marked by an increase in mid-market defaults,” Haynes said.
While it often takes time for economic pressures to pass through a company’s income statement or balance sheet, most companies are able to cross the trough in a relatively short period of time. But if these adverse conditions persist for more than a year, they become a worrying problem and could lead to more serious problems, he added.
Jason Friedman, global head of business development at Marathon Asset Management, said he expects default rates in the private credit market to rise later in the cycle, eventually catching up with the leveraged loan market. Stated.
Lenders with strong loan origination and restructuring capabilities have a better ability to achieve the best possible recovery. Many private lenders have been preparing for a turn in the credit cycle for years, building training teams even when there are no major problems. But some companies are doing little to prepare for the coming storm.
“I don’t think middle market lending investment managers have a uniform skill set.” [in loan workouts]”There will be winners and there will be losers,” Haynes said.
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