Loan Note: Rate rises contributing to predicted default rise; direct lending performance holding up well

European defaults on the rise as borrowers come under pressure. Plus: Cliffwater has good news on performance for direct lending; and why larger funds are benefiting in the sub lines market. Here’s today’s brief for our valued subscribers only.

They said it

“Refinancing risk amidst a higher cost of capital environment remains a key focus for credit market participants, emboldened by the ongoing upward pressure on US interest rates across the curve”

Taken from BlackRock’s latest Global Private Credit Weekly

First look

Burdens build: European defaults heading up (Source: Getty)

European defaults rise as rate pressure applied
“The burden of increasing interest rates continues to build,” says S&P Global Ratings, as it tips the European trailing 12-month speculative grade corporate default rate to reach 3.75 percent in June next year – up from this year’s June figure of 3.0 percent.

Although the forecast is more optimistic than the last one in March, the challenges are still evident. “While a recession may well be avoided, growth is still stagnating and cash interest paid has risen roughly 15 percent from a year ago for European firms during the second quarter,” said Nick Kraemer, head of S&P Ratings Performance Analytics, in a recently published article (login required).

S&P identifies firms’ ability to service debt amid flagging cashflows as the main risk. Some protection is offered by high cash balances or the ability to free up cash through hiring cutbacks, stock buybacks or dividends – but these options are less available to lower-rated issuers.

The consumer products sector had the highest number of so-called “weakest links” in Europe in the second quarter. This was driven by inflation contributing to weaker consumer sentiment and a shift in demand from branded consumer goods to private label and discounted products.

Direct lending going strong
US direct lending has been experiencing a strong period for performance, according to the Q2 2023 version of the Cliffwater Direct Lending Index.

According to the CDLI, the second quarter saw a 2.81 percent return, following a 2.69 percent return in the first quarter. The increase has been driven by growth in income as a result of higher interest rates. CDLI yield climbed to 12.07 percent during the second quarter.

CDLI-S, the senior debt-only version of the index, returned 2.78 percent in the second quarter, while CDLI-V, the venture debt-only index, delivered 3.13 percent.

The CDLI trailing-year return stands at 9.69 percent and the annualised return since inception of the index in 2004 at 9.37 percent. A statement from Cliffwater said private debt was today’s “fastest growing institutional asset class”.

On a less positive note, credit losses are on the rise – although they have still not yet reached the long-term historical average of 1 percent. The near-zero loss years of 2021 and 2022 may not be seen again for a while, however. Cliffwater said most signs of loan stress showed only “modest” changes.

Reduced M&A activity has contributed to a worsening liquidity environment and seen the average loan life move up to 5.26 years at the end of June from its 3.07 years historical average.

Size matters in European sub lines
Insufficient liquidity in Europe’s subscription line market benefited large GPs at the expense of mid-size ones in the second quarter, our colleagues at Private Funds CFO report.

Data from law firm Cadwalader found that pricing for big sponsors declined from Q1 levels while rising for mid-size ones. Lenders preferred engaging with bigger managers in Q2 because of their perceived lower credit risk due to more diversified borrowing bases, Michael Hubbard, head of European GP solutions at Cadwalader, told Private Funds CFO, noting that longer fundraising periods are also contributing to higher pricing for mid-size sponsors because they have less diversified LP bases when they seek sub lines at their first close.

These pricing discrepancies are also a clear sign that there is not enough credit from banks to go around for both groups of managers, or even all of the largest managers. “The amount of capital across the banking market for subscription lines is not infinite,” noted Samantha Hutchinson, a partner at Cadwalader. And growth in big GPs’ fund sizes means they need more sub-line capital, posing allocation challenges for banks.

Cadwalader’s advice to avoid this looming supply-side crunch? Attract capital from institutional investors. The law firm is spending more time exploring models to accommodate non-bank capital providers. “For that to have gone from taking up very little of our time three years ago to taking up a considerable chunk of our time really just underlines how big an issue this is for the subscription market,” Hutchinson said.


PDI Rising Star claims new role at Tikehau
Among a number of appointments at Paris-based manager Tikehau Capital, Maxime Laurent-Bellue – one of PDI’s Rising Stars of 2020 – has been handed the role of head of structured credit on top of his existing role of head of tactical strategies.

Laurent-Bellue joined Tikehau in 2007 and, since 2008, has helped develop the group’s private credit division and been involved in new investments and fundraising. He has also played a role in strategic launches for segments including special situations, direct lending and leveraged loans.

Laurent-Bellue was 35 at the time of his inclusion in Rising Stars three years ago. It was noted that he had been instrumental in forming a partnership with Fideuram-Intesa Sanpaolo Private Banking, through which €420 million was raised during Q4 2019 and Q1 2020 from almost 3,000 private Italian investors.

Other new roles were handed to: Henri Marcoux (existing deputy chief executive officer and now also president of Tikehau Investment Management); Bruno de Pampelonne (executive chairman of Tikehau Capital Asia and special adviser to the group’s co-founders); and Frédéric Giovansili (existing deputy chief executive officer of Tikehau Investment Management and now also deputy chief executive officer of Tikehau Capital).

UK and Dutch DFIs back Ethiopian bank
British International Investment, the UK development finance institution and impact investor, and FMO, the Dutch entrepreneurial development bank, have made a joint commitment of up to $20 million each to Dashen Bank, one of Ethiopia’s largest private sector banks. The loan will help drive agricultural exports and provide access to much-needed foreign exchange within Ethiopia.

BII and FMO are supporting Dashen Bank in bolstering the country’s agricultural sector, which employs 80 per cent of the population, contributes 39 per cent to GDP and generates 90 per cent of its foreign currency from exports.

By providing capital for the expansion of growing businesses, the facility enables Dashen to provide USD-denominated loans to cover the costs of importing machinery – supporting farmers towards increased productivity in areas such as harvesting, logistics, and processing and boosting exports earnings.

LP watch

Institution: Los Angeles Fire & Police Pension System
Headquarters: Los Angeles, US
AUM: $29.4 billion

The Los Angeles Fire & Police Pension System has committed to a fund managed by Boston-based Charlesbank Capital Partners.

The public pension confirmed a $20 million commitment to Charlesbank Credit Opportunities Fund III in a recent board meeting. The fund targets subordinated/mezzanine corporate debt in North America.

The fund was launched in June 2022 and recently reached a first close of $973.85 million.

Platinum subscribers may click here for the investor’s full profile, including key contacts, allocation strategy and fund investments.

Today’s letter was prepared by Andy Thomson with John Bakie, Christopher Faille and Robin Blumenthal contributing