What happens to loans in an age of inflation?

UK economic data has produced something of a shock, highlighting the need for private debt managers to consider the consequences of changed circumstances.

Those looking for evidence of the much-hyped inflationary environment we’ve been told to expect will no doubt have noted with interest the leap in UK inflation announced by the Bank of England this week, from 2.0 percent in July to 3.2 percent in August. It was the biggest monthly rise in the UK for almost a decade.

In the cover story of our upcoming October issue, we seek to discover what inflation might mean for the private debt market. Not everything we heard was encouraging. He said it before the announcement came, but Emmanuel Deblanc, head of private markets at Allianz Global Investors, could almost have had the UK data in mind when he told us: “As rates increase, will that stress the servicing of the debt? The big challenge for lenders would be if there was a sudden shock and change in the inflation paradigm.”

Deblanc’s reference to a paradigm change speaks to the second big question about inflation. The first is ‘will it happen?’ The second is ‘how long will it last?’ Some think there could be a danger of overreacting if inflation proves to be temporary rather than long-lasting. Worth keeping in mind, after all, that alternative investments, including loans, are generally long-term in nature and thus well placed to ride out short-term economic adjustments.

On the other hand, should inflation prove to be a game-changer, there are plenty who say private debt has nothing to be afraid of. There are some specific reasons for this, such as the floating rate nature of many loans, which should protect them from interest rate increases and mitigate any impact on returns.

There’s also a sense that private debt has, through covid, demonstrated a resilience that no-one was sure it possessed given that the preceding period was one largely assisted by economic tailwinds. An Adams Street Partners report out this week said private credit yields are currently around 270 to 300 basis points higher than those available for comparable investment options such as the high yield and leveraged loan markets. Unsurprisingly, perhaps, investor faith in the asset class remains strong.

Write to the author at andy.t@peimedia.com