Signs of stress

The combination of a mature cycle and global turbulence gave participants at PDI’s Capital Structure Forum pause for thought.

To say we live in a fast-changing world is to state the glaringly obvious given the succession of alarming events we keep reading about and seeing on our TV screens. But taking soundings from the private debt asset class in recent months has been akin to discovering an alternative reality.

Even following the Brexit vote, very few GPs seemed unduly alarmed – and this was notable given that the UK accounts for almost half of Europe’s private debt market in deal volume terms. Some said their portfolios largely comprised national leaders that would not be unduly affected by currency fluctuations and events in the wider world. Others went further by fully embracing the outcome, pointing to another likely bank retreat as an opportunity to grab even more market share.

As surely as the seasons change, however, so does market sentiment. At this week’s PDI Capital Structure Forum in London, it was possible to detect such a shift. To be clear: many were still singing from a hymn sheet titled ‘business as usual’. But it was notable how much emphasis was given to the maturity of the credit cycle and the range of potential triggers – whether the US election, China, the Middle East, oil, terrorism, the list goes on – that could tip the global economy into a serious downward economic spiral.

At a networking session, one managing director of a US GP said his firm was of the view that it could well be within the next one to two years that economic travails begin to be reflected in some serious credit stress. For him, this would not be an unwelcome scenario given his firm’s plans to launch a distressed fund in the near future.

There were plenty of dissenting voices claiming the benign cycle could yet proceed uninterrupted for another few years. But some of the more positive arguments that have been frequently offered this year are now being challenged. The fact the bulk of companies in direct lending portfolios in Europe were small, and often with a domestic market focus, has been held up as evidence of a protective layer from wider global forces. However, as one panellist pointed out, small companies have limited pricing power in the face of an increase in raw material costs.

What seemed significant was that, when arguments were made in favour of the good times continuing to roll, there frequently came a counter-argument of potential difficulties ahead. Depending on the nature of your strategy, a more challenging environment could be welcome or highly unwelcome. Either way, there is a growing sense of a cycle on the turn.