Loan Note: Investors keen on private credit allocations; default rates tipped to rise

EY survey shows investors bullish on private credit. Plus: Fitch and S&P both expect rising default rates; and Monroe points to still-subdued leveraged loan issuance. Here's today's brief for our valued subscribers only.

They said it

“It’s been a rough ride in 2022 for the markets, but the indications are such that we expect more favourable conditions for the year ahead, and increasingly so, as we move through 2023”

Nigel Green, chief executive of UK-based financial advisory firm deVere Group, in a press release

First look

A skip in the stride: Investors confident about private credit allocations (Source: Getty)

EY survey: Investors are bullish on private creditA just-released survey by EY found that the majority of investors, or 51 percent, plan to increase their allocations to private credit, and that private credit was the recipient of more bullishness than any other surveyed asset class. In its 2022 EY Global Alternative Fund Survey, the latest in an annual series that looks at the world of alternative fund managers and their institutional investors, EY found that more than half (55 percent) of investors surveyed said their private credit managers met their expectations.EY’s collaborator in the project, Coalition Greenwich, questioned 61 institutional investors, representing approximately $1.3 trillion in assets under management.The survey found that many fund managers are expanding into new asset classes. For example, 32 percent of hedge fund managers increased their exposure to private markets investing. Also, fund managers of all types are seeking to capture inflows by expanding into opportunistic and special situation deals and launching new fund structures.The survey involved 114 interviews with hedge funds and 112 interviews with private equity firms.Looking at the macro picture, the survey suggests that very few market participants expect a lessening of volatility. Only 13 percent of managers, and the same percentage of investors, believe that there will be a return to “more normalised patterns going forward”. At least three times that many believe there will be “severe market impacts due to geopolitical shocks” over the next 12 months (39 percent of managers and 46 percent of investors).

In a statement issued with the survey’s release, Jun Li, EY Americas wealth and asset management co-leader, said: “While the financial industry has come a long way since 2008, the findings from this year’s Global Alternative Fund Survey suggest that there’s still much to be done if many of these boutique managers are going to be competitive in an industry undergoing increased consolidation.”Managers understand that the regulatory environment is shifting and that comes with costs. Forty percent of the hedge fund managers surveyed say that their budget for compliance and/or regulatory processes will likely increase by between 5 percent and 10 percent over the next two years. Another 18 percent of managers say that it will increase by more than 10 percent.Europe’s loan defaults set to riseEuropean leveraged loan default rates are set to rise significantly in 2023 and 2024, according to the latest ‘At-Risk’ report from Fitch Ratings.An expected default rate of 1.3 percent for this year is tipped to rise to between 4.5 percent in a base-case scenario and 6.0 percent in a severe-case scenario, with the respective figures for 2024 forecast to be 4.0 percent and 6.0 percent.Fitch had previously forecast a less negative scenario for next year but said the view had changed due to “limited refinancing alternatives for an increasing number of issuers with high leverage and principal maturities due in 2023 and 2024”.High-yield bond defaults are expected to be lower than loan defaults next year, with bonds having fewer floating-rate issuers affected by benchmark rate rises, fewer issuers with near-term maturities and smaller number of issuers in the triple-C category. However, Fitch says it expects bond and loan defaults rates to equalise in 2024.Fitch also predicts an increase in amend-and-extend transactions, whereby borrowers request an extension to a facility’s maturity in exchange for changes to key terms.


European corporates under pressureThe European 12-month trailing speculative-grade corporate default rate is expected to reach 3.25 percent by September next year, compared with 1.4 percent in September this year, according to an article (login required) from S&P Global Ratings.The rising default rate is attributed to slowing economic growth, recession in the UK, increasingly difficult financing conditions and falling profit margins. Downside risk has increased due to Europe’s recession odds rising as a result of climbing interest rates and volatile energy prices.“With inflation remaining high and central banks raising rates quickly, any shock to energy prices would push consumer spending down, which would likely result in even more interest rate hikes,” S&P said.Leveraged loan market woesInstitutional leveraged loan issuance remains extremely subdued, according to the latest monthly market update from Monroe Capital Markets.Month-to-date issuance through 27 October stood at $4.1 billion, down 92 percent from the comparable period of 2021. The year-to-date figure is $194.3 billion, down 64 percent from the prior year’s comparable period.In the year-to-date to 27 October, leveraged buyout issuance was down 48 percent, M&A issuance down 60 percent and refinancing issuance down 75 percent.Monroe pointed out that the low levels of activity presented direct lenders with an opportunity, but noted they have “increased scrutiny across sectors as recession concerns grow and near-term liquidity is being squeezed”.Round2 Capital completes first closing of software lending fundThe Vienna-based firm’s second fund has so far raised €62 million as it heads towards a €100 million target. The fund, based in Luxembourg, backs European growth companies offering business-to-business software critical to success, with typically €5 million to €25 million of annual recurring revenue.A pan-European firm with an actively managed revenue-based credit strategy, Round2 has invested in more than 25 companies across eight European jurisdictions. The new vehicle will finance up to 40 small- and mid-cap software companies in Europe, with a particular focus on the DACH and Nordic markets.

LP watch

Institution: Florida Retirement System Trust FundHeadquarters: Tallahassee, USAUM: $228 billion Allocation to alternatives: 21.5%

Florida Retirement System Trust Fund has confirmed a $100 million commitment to Edelweiss Group‘s second Special Asset Fund, according to its Q3 2022 reports.

Edelweiss India Special Asset Fund III (EISAF III) will invest in the corporate and real estate sector in Asia-Pacific.

The $228 billion US public pension fund’s commitments tend to focus on North American, Asia-Pacific and European vehicles targeting distressed and subordinated/mezzanine debt.

Today’s letter was prepared by Andy Thomson with John BakieChristopher Faille and Robin Blumenthal