The Alternative Credit Council (ACC) and SS&C Technologies (SS&C) conducted a survey of private credit managers and received responses from 56 private credit managers and investors. The survey data was then explored by the ACC and SS&C in a "Financing the Economy 2023" series of one-on-one interviews.
This is the first blog in a series where we will examine some of the key takeaways.
Despite the dramatic increases in central bank interest rates this past year, the private credit sector has shown resilience and appears to be in a strong position to expand its footprint in the corporate sector. There were fears that the higher interest rates would result in higher instances of stress or defaults in the credit markets, but the consensus is that there has been less of an impact than expected across portfolios and the broader market. In fact, the stress that has been seen appears to be related more to external forces like COVID-19 rather than a direct result of the high-rate environment. This is likely due to the actions of private credit firms to manage risk effectively.
While private credit managers have continued to focus on sectors like business services, healthcare, software, etc., other niche sectors have become attractive for their low capital expenditures and resilience to macroeconomic conditions—sectors like industrial maintenance and repair companies. Another area contributing to private credit resilience is the practice of proactively mapping how many portfolio companies are hedged, which has helped managers better understand and mitigate their risk exposure.
One way that this current period is different from previous periods of stress is that many managers report feeling like they have more control over problems in their portfolios. By having control over the interest rates being applied to portfolio companies, managers can choose from a wide range of options to deal with the repayment risk. For instance, while not a permanent solution, Payment in Kind (PIK) instruments can provide time for businesses to adjust to interest rates while retaining value for credit investors. This is helpful for companies with viable economic prospects where the sponsor or management team is fully committed.
A higher interest rate environment increases demand on cash flows, which puts immediate pressure on corporate businesses. While this effect is already appearing in many companies, there is likely a lag effect that will lead to more issues surfacing in 2024. Debt coverage ratios are coming down from their typical levels, but are still far from the levels that would present real challenges. This is because many portfolio companies are able to meet higher debt costs through the growth of their underlying earnings. Alongside this strong earnings growth, lenders are also taking steps to increase their understanding of whether the growth will persist, such as requesting minimum cash balances or requiring greater visibility on the source of cashflows.
To learn more about how private credit managers are showing resilience in a high-interest rate environment, download our "Financing the Economy 2023" report.
Written by Bhagesh Malde
Head of SS&C GlobeOp