Private debt markets face reality check as companies grapple with recession

LONDON: 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 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 dial back on lending to corporates — particularly riskier ones. This opened the way for investment funds, such as Blackstone, to fill the gap and lend money to companies, which are often owned by private equity firms.

But the private debt market — the fastest-growing in the 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 from $250 billion in 2010, according to data provider Preqin, 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, which makes for a much tougher environment for corporate borrowers.

WARNING SIGNS

As central banks drain trillions of dollars of extra cash they pumped into the economy over 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% on US dollar-denominated deals 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 low during the past 18 months so it’s 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.