Private debt markets face reality check as companies grapple with rising rates, recession

Stellar growth in private debt markets over the past decade looks set to face a reality check as a looming recession and higher interest rates squeeze companies' earnings and their ability to…

Private debt markets face reality check as companies grapple with rising rates, recession
  • Private debt market has grown to $1.4 trillion since 2010 * Defaults on private credit have been on rise from low base * Central banks ramp up in rates adds to pressure * Private credit funds look to in-house restructuring, legal

experts LONDON, Dec 20 (Reuters) - Stellar growth in private

debt markets over the past decade looks set to face a reality

Check out the looming recession and high interest rates squeeze

companies' earnings and their ability to service borrowing

costs. An era of ultra-easy cash from central banks lured investors

into private credit, attracted by juicy returns in the

high-single to low-double-digits. Regulation in the wake of the global financial crisis forced

Banks to reduce lending to corporations -- especially

These are more risky. This allowed for the creation of investment funds such as

Blackstone was created to help fill the gap in financing and to lend money to companies.

Private equity firms often own these companies. Private debt markets -- which are the fastest growing in the country -- are often owned by private equity firms.

credit sector since the financial crisis -- is about to hit a

speed bump as investor appetite for risky assets is tested by

aggressive monetary tightening and recession. The private debt market has expanded to $1.4 trillion, up

According to Prequin data provider, the 2010 figure was $250 billion

with funds including Ares, Blackstone and KKR

holding big positions. "Some of those companies – particularly in the mid-market

space – will face real difficulty, especially if it's not, as

the market is anticipating, a shallow recession," said Jason

Friedman, Global Head of Business Development at Marathon Asset

Management. The jury is out on how private lenders will react if the

downturn might be more prolonged rather than "six months and I'm

through it", said Friedman, with the threat of a lengthy decline

in earnings and potentially higher defaults looming large. Major central banks have ramped up rates at breakneck speed,

the European Central Bank is delivering its fastest tightening

cycle ever. Meanwhile, the global economy is expected to tip

into recession as high rates and inflation take their toll,

This creates a more difficult environment for corporates

WARNING SIGNS Central banks drain trillions in extra cash

They pumped money into the economy for the past decade, warning signs

are already flashing, such as a surge in redemption requests at

an unlisted Blackstone real estate income trust. Corporate default risks are rising, making investors think

twice about holding riskier private debt. A Private Credit Default Index by law firm Proskauer showed

A default rate of 1.56% applies to U.S. Dollar-denominated transactions in the

third quarter, the first notable increase over the past 18

months. This is similar to a 1.6% default rate in the public debt

markets for speculative-grade corporates in the United States,

based on data as of September 2022 from S&P Rating. The agency expects the speculative-grade default rate to hit

3.75% by September 2023. "The (private credit deals) default rate was extraordinarily

It was low over the last 18 months, so it is not surprising to see it

rise, particularly when the market is generally under pressure,"

said Peter J. Antoszyk, Co-Head of the Private Credit

Restructuring Group at law firm Proskauer. "While the default rate is likely to go up, I wouldn't

expect to see a significant spike in 2023," he added. After the COVID-19 pandemic, support from private equity

owners and private creditors helped to keep payment defaults to

a minimum, according to S&P Global Ratings. Whether that happens in the coming year depends on the

severity of any recession. "In the worst-case scenario of a protracted recession, some

of these businesses will need to restructure their debt in a

higher rates environment and perhaps raise the cost of funding

to 10% interest plus – I am not sure how they will all be able

to come out of it," said Ruth Yang, Global Head of Thought

Leadership at S&P Global Ratings. PROS AND CONS The private, largely bilateral nature of the market could

prove to be a saving grace. Yannick Le Serviget, Global Head of Leveraged Loans and

Private Debt at 184 billion euro asset manager AXA IM Alts, said

one advantage was companies have to deal with only a handful of

lenders rather than a large pool of creditors, making it easier

to extend maturities and survive a downturn. But a big challenge will be cash management with companies

often not having a variety of financing lines to access

regularly. "If they need cash, the capacity of the shareholders to put

additional money in the business will be critical," Le Serviget

said. A number of debt funds are looking at strategies such as

bringing restructuring and legal experts in house to tackle

potential problems at companies in their portfolio in advance. But it is not all doom and gloom. "There will be very interesting (prospects for) rescue

financing and opportunistic lending, where if you can see

through the problem twelve months from now, you can finance your

way through it," Friedman said. (Reporting by Chiara Elisei, editing by Dhara Ranasinghe, Karin

Strohecker and Jane Merriman)