Default rate drops, especially for larger firms
Just when the US private credit default rate appeared to be tracking predictions of a steady increase, the latest survey from law firm Proskauer has shown a surprising decrease. The question now will be whether this is a one-off blip or a sign that the asset class has already weathered the storm – much as it swiftly did in the aftermath of the first covid outbreaks.

The Proskauer Private Credit Default Index for the second quarter of this year showed a drop in the overall default rate to 1.64 percent from the previous quarter’s 2.15 percent, following two successive quarters in which the default rate rose.

The decline was particularly notable among larger businesses, with the rate dropping to 0.8 percent for companies with EBITDA at the time of loan origination of more than $50 million. The rate for such companies was 2.6 percent in the first quarter of the year.

Companies with between $25 million and $49.9 million of EBITDA saw their default rate go down from 2.0 percent to 1.6 percent, while only smaller companies saw an increase – those with less than $25 million of EBITDA saw the rate climb slightly from 2.0 percent to 2.1 percent. Of relevance here is that smaller companies are more likely to have a greater number of financial covenants.

The survey revealed a big drop in defaults for the hard-hit consumer goods and services sector, falling from 8.0 percent in the first quarter to 5.3 percent in the second. Other significant falls were seen in manufacturing (1.3 percent), healthcare/life sciences (1.1 percent) and business services (0.7 percent).

The index tracks senior-secured and unitranche loans in the US. The Q2 2023 Index included 977 active loans, representing $144.9 billion in original principal amount.

AIFMD changes a ‘mixed bag’
While describing them as a “mixed bag”, changes proposed in the Alternative Investment Fund Managers Directive review have been broadly welcomed by trade bodies.

Political agreement was reached last week on reforms to delegation and liquidity management, which the Alternative Investment Management Association and Alternative Credit Council said “remain targeted and validate established practices that both policymakers and asset managers agree work well”.

AIMA/ACC noted that asset managers will continue to benefit from the ability to delegate portfolio or risk management to third parties “albeit with more requirements on substance and greater transparency to regulators regarding delegation arrangements”. In addition, they said firms will be subject to tighter restrictions around liquidity risk management.

The agreement also includes new rules for loan origination funds (LOF) aimed at addressing financial stability concerns. The main purpose was to try and ensure that LOFs that lend on a cross-border basis would do so based on a single set of European Union rules. The upshot is that LOFs will face higher levels of regulation when it comes to liquidity risk management, leverage and retention of loans to avoid “originate to distribute” models.

New leverage limits for LOFs will likely be put in the legislation, set at 175 percent of NAV for open-end funds and 300 percent of NAV for closed-end funds.

The changes are provisional, with nothing confirmed until the legal text is finalised and published. Member states and the European Commission will then have 18 months to integrate the directive into national law.

Jiri Krol, deputy chief executive officer and global head of government affairs at AIMA, welcomed the new rules on delegation, liquidity risk management and passporting for LOFs as “relatively sensible”. However, he said restrictions such as those on leverage limits were “difficult to justify”.

“As usual, it’s a mixed bag and we hope the positive elements will outweigh the negatives,” he added.

Credit stays calm in the storm
“What comes next for credit?” is the question posed by investment manager Man GLG in its Q3 2023 Credit Outlook. On the whole, the answer seems to be positive – especially if your focus is Europe.

“Despite the rate rises, and at this stage of the economic cycle, the credit markets remain much calmer than might be expected,” reads the report. “There is a reasonably positive tone to the markets: yes, inflation remains sticky, but attractive all-in yields and low default rates are maintaining the attractiveness of credit.”

The firm says talk of the turning of the credit cycle has been around for some time, but that the resilience shown has been surprising, including in the lower-quality portions of the loan and high-yield bond markets. However, it does expect tightening monetary policy and reduced bank lending will still lead to pressure on this part of the market.

Within fixed income, Man GLG expresses a “clear preference” for European credit over US credit given the downturn in commercial real estate and deposits flowing out of US banks, which “face a number of headwinds”. European banks “remain in a stronger position and can manage despite the headwinds of a slowing economy”.

The report notes that the leveraged loan and CLO markets have shown robust performance in the year to date, with the regional banking woes having been shrugged off. However, central bank policy, reduced bank lending and signs of a slowdown in manufacturing are all reasons for a cautious approach, according to Man GLG.

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