Loan Note: Pressure increasing on mid-market borrowers; UK and senior debt dominate European RE debt funds

Mid-market borrowers will struggle to generate enough cashflow to cover interest expenses, according to KBRA. Plus: the UK and senior debt closed-end funds dominate Europe's debt fund market; and S&P finds negative rating pressure building. Here's today's brief for our valued subscribers only.

They said it

“Early in the year, the expectation was 75bps in total rate hikes for all of 2022. Today that’s just a normal meeting hike!”

Taken from the ‘Of Rates and Recessions’ Weekly Commentary, part of the Lead Left digest published by Randy Schwimmer of Churchill Asset Management.

First look

Pressure rising: KBRA predicts cashflow difficulties (Source: Getty)

KBRA: Higher rates will pressure interest coverage from cashflow
Credit rating agency KBRA expects that anticipated rate hikes by the US Federal Reserve will cause a number of the mid-market borrowers in its universe to lose their ability to generate enough cashflow from operations to cover their interest expenses.

KBRA conducted a stress test (login required) of 1,900 non-investment grade companies of the total 2,400 unrated issuers that it evaluates for creditworthiness and assumed that future rate hikes will add as much as 225 basis points to borrowers’ costs by the end of the first quarter of 2023.

The stress test excluded the impact of downward recessionary pressures on revenues and upward inflationary pressures on costs – all of which, KBRA says, along with higher interest costs – will begin to fully manifest in corporate cashflows in the current quarter and the first quarter of next year.

“Roughly 16 percent of the 1,900 companies that were previously able to cover interest from current cashflow will need to be supported in an alternative way in a 12 percent interest rate environment,” says William Cox, KBRA’s global head of corporate, financial and government ratings. He said that some of the credits at the lower end of the spectrum “were already supporting interest expense through alternative sources of liquidity”.

While the added pressures won’t necessarily result in defaults, the report gives “a sense of the incremental percentage of companies that will need to be managed by lenders in ways different than originally contemplated”, Cox said.

UK, senior debt dominates INREV study
According to the 2022 INREV Debt Vehicles Universe study, the European non-listed real estate market has grown to 98 vehicles with a total target equity of €60.3 billion. Over the past seven years, vehicles in the study have more than doubled in number and size.

The UK, Europe’s most developed non-listed real estate debt market, is leading the way. Bayes Business School’s recently published Commercial Real Estate Lending Report H1 2022 revealed that, at 38 percent, non-bank lending in the UK surpassed that of bank and building society lending in the space for the first time on record.

The majority (85.1 percent) of total equity is concentrated in closed-end vehicles and 64.3 percent is focused on a senior loan debt strategy. The number of closed-end vehicles has risen sharply from 37 in 2016 to 80 in 2022. Liquidity concerns at least partly explain their dominance, especially given the relatively small size and immaturity of the European non-listed debt market.


S&P: Some hope but also negative pressures
In its latest This Week in Credit report – titled The Rumble of Rating Pressure – S&P noted a boost to markets amid hopes the US Federal Reserve may be nearer the end of its rate hike cycle than the beginning.

However, it also pointed out that markets are “far from settled” with volatility likely to continue for as long as inflation remains troublesome. It said negative rating pressure was still building, with negative actions “far exceeding” positive ones.

Downgrades, negative outlooks and risky credits had all increased over the last week, with speculative-grade issuers most exposed to tight capital markets and deteriorating macroeconomic conditions.

The media and entertainment, retail/restaurant and consumer products sectors accounted for 35 percent of negative rating actions between them but cashflow deterioration was also noted among some technology issuers.

Credit spreads tightened in the US and Europe but widened in Asia-Pacific as global primary market volume picked up, led by investment-grade financial institutions in the US and Europe.

Join us in Seoul and Tokyo
With the headwinds facing Western economies, Asia-Pacific is once again under scrutiny for investors considering whether to re-allocate resources to a part of the world where demand for new sources of finance is increasing.

This makes our latest Private Debt Investor events extremely timely, as we visit Seoul on 8 November and Tokyo on 10 November for our Japan Korea Week 2022. The event features our usual mix of keynote interviews, panels and presentations with industry leaders based in and outside the region. Make sure to book your place as soon as you can.

LP watch

Institution: Teachers’ Retirement System of the State of IllinoisHeadquarters: Springfield, USAUM: $63.27 billionAllocation to alternatives: 6.7%

Teachers’ Retirement System of the State of Illinois confirmed a commitment of $125 million to Brookfield Infrastructure Debt III, a source at the pension fund told Private Debt Investor.

Founded in 1899, Brookfield Asset Management is an asset manager focused on investing in high-quality assets across real estate, infrastructure, renewable power and private equity. The fund’s predecessor had a final close on $2.7 billion in December 2020.

TRSIL’s recent fund commitments have predominantly focused on the corporate sector in North America.

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