Debt’s latest challenge: Unflattering headlines

Private credit firms are under the microscope as rising interest rates create turbulent times ahead for borrowers.

Remember when private equity firms were described as “locusts” in Germany, and it was not unusual for such firms to be viewed as money-grubbing asset strippers? A reminder of this comes via some good old-fashioned emotional language, this time in The Economist and aimed squarely at debt rather than equity providers (login required): “A reckoning has begun for corporate debt monsters.”

It may come as a something of a surprise, to say the least, for the more ‘steady as you go’ debt industry to find itself under scrutiny in quite such a searing manner. Not many of our sources will readily identify themselves as monsters – based on our sources, we’d say quite reasonably. The thrust of The Economist piece is that the surge in borrowing costs will place possibly unsustainable strain on many businesses as they – in the face of meagre supplies of bank finance – “come to rely on less orthodox sources of credit”. It’s an unwelcome hint of the “shadow banking” tag that non-bank financiers have fought hard to shake off over the years.

It’s also a reminder that the PR battle is never won, it just subsides in the good times and then comes roaring back when things get tough. Although The Economist cites various sources of debt, including the leveraged loan markets, private credit is specifically referred to as offering loans that “tend to tolerate higher leverage in return for high and, more troubling at the moment, floating interest rates”.

This is a bit of a catch-22 for fund managers, since claims that private debt can weather the current difficulties rather better than other investment options rest to a large extent on the premium they’re able to charge for flexible financing. All well and good, until borrowers start to notice this in-built flexibility assisting them in their movement towards a cliff edge. At that point, there’s only one way down for both returns and reputation for all parties to the deal.

It’s not as if the threat hasn’t already been noted and acted upon. In our October cover story, to be published online next week, we report on the latest borrower/lender tussles over covenants – and it’s fairly clear that lenders are keen to rein in some of the leeway that borrowers have been granted to pile more debt onto their balance sheets. But this is in relation to deals being done today. The worry, as borrowing costs rise, is how much damage may already have been done.

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