Talking point: The default story that may have a further twist

“While we are not out of the woods, we have seen a large number of loans return to performing credits, and we expect that trend to continue for the foreseeable future.” These were the cheering words of Stephen Boyko, co-chair of law firm Proskauer’s private credit group, in response to the findings of the firm’s Q1 2021 Private Credit Default Index.

Looking at the figures, Boyko appeared to have good reason for optimism. The index, which tracks the default rates of senior secured and unitranche loans, saw the rate shoot up to 8.1 percent in the second quarter of last year, but drop the following two quarters to more normal levels – 4.2 percent in Q3 and 3.6 percent in Q4. The first quarter of 2021 saw the rate fall further, to 2.4 percent overall and a very healthy-looking 1.0 percent for companies with EBITDA of more than $50 million.

It seems clear, for now at least, that any imagined parallels with the global financial crisis can be dismissed. The pandemic has presented challenges to businesses, as the Q2 2020 default rate makes clear, but nothing on the scale of the devastation seen in 2009.

A major difference this time, as has been well documented, is the government support schemes that have buttressed many companies.

Finite support

While these schemes have been invaluable, and undoubtedly provide a template for future crises, they are only temporary. And when the life support system is switched off?

A study published in May 2021 by corporate and fiduciary services firm Ocorian found that nearly half (47 percent) of capital market investors with direct lending strategies lacked confidence in their ability to manage loss recoveries, “which could have serious implications if default rates rise as pandemic-driven government support schemes are withdrawn”. This was particularly true of European managers and those that had been around for less than 10 years.

There has been a lot of talk in the market about how sponsors and lenders have worked together impressively to steer portfolio companies through these tough times. But as with the pandemic, the first wave is not necessarily the last or the biggest. Optimism seems appropriate, but of the cautious variety.