As investors increasingly allocate capital across the private debt markets, evolving macro and financial conditions may necessitate a need for greater transparency.
Private credit has long been an important source of funding for small and middle-market borrowers, alongside the broadly syndicated loan and speculative-grade bond markets. But it wasn’t until recently that the private credit market has seen such explosive growth. This decade-long expansion (against the backdrop of rising credit pressures) has put the focus on the burgeoning risks in an opaque market.
The risk factors associated with private credit are the same as those for mainstream credit—but the emphasis will differ depending on where a borrower is in its life cycle, as well as broader credit conditions. As signs of credit stress emerge and defaults creep up, it remains to be seen whether this “golden age of private credit” can continue.
At S&P Global Ratings, our independent opinions on creditworthiness take a holistic view to provide greater transparency for the totality of private markets participants—from direct lending, business development companies, and middle-market collateralized loan obligations, to private equity, fund financing, and beyond.
Some global alternative investment funds (AIFs) will come under pressure in the next year. For private equity and venture capital in particular, valuations are uneven, fundraising is slowing, and liquidity needs are rising for AIFs and their portfolio companies. In this context, we expect that some AIFs will gradually turn to debt to invest in assets, return capital to investors, and support their portfolio companies. Fresh fund-level debt will worsen our view of AIFs' leverage and liquidity incrementally, testing the rating foundations. However, we expect that ratings on most funds under our coverage will remain solid, thanks to the low amount of fund-level leverage already in the industry and a degree of contingent liquidity.
The AIFs that we rate take various forms. Typically, but not necessarily, they are set up using a fund structure and can invest in a diverse range of public and private assets. These may include private equity investments, private debt, real estate, commodities, hedge fund strategies, and fund of funds investments. AIF raise a mix of permanent or nonpermanent capital as a source of financing. We distinguish AIFs from alternative asset managers, which generate revenue from management fees charged as a percentage of assets under management, performance fees, and investment income through their underlying general partner commitments in the funds they manage. AIFs depend on their absolute investment performance.
In an effort to provide insights on the broader private debt market, we generated a scenario analysis on more than 2,000 credit estimated (CE) issuers with more than $400 billion of aggregate outstanding debt to help assess middle-market issuer durability in the face of rising interest rates and margin erosion. Most borrowers for which we have credit estimates are highly leveraged, and median credit metrics could approach precarious levels under moderate or severe stress scenarios. Some CEs scored predominantly at 'b-' could present characteristics often associated with the 'ccc' category and may be at risk of downgrades under these scenarios, potentially increasing the proportion of 'ccc' assets in middle-market collateralized loan obligations (CLOs). Even though we expect less than half of the issuers would generate positive free operating cash flow (FOCF) in a mild stress scenario, overall liquidity appears supportive for the near term. Like broadly syndicated loans, debt maturities for CEs appear manageable for the next 12-18 months, but a sustained higher interest rate environment would cripple many issuers ahead of a heavier maturity schedule that begins in 2025. Although default rates have remained low, recent downgrade trends point to vulnerabilities in the middle market.Read More
Business development companies' (BDCs) public filings of their asset holdings provide some insight into the private credit market. In the 12 months through first-quarter 2023, private credit loans accounted for much of the growth of BDC assets, and non-traded BDCs grew at a faster rate than publicly traded BDCs. Maturities of private credit loans that BDCs hold peak in 2028, as do broadly syndicated loans in the U.S., which could add to funding pressure as interest rates remain higher for longer. Yields on private credit loans increased by 350 basis points over the year (rising to an average of 10.7% in first-quarter 2023) and are higher than those on broadly syndicated loans, though the gap has narrowed.Read More
For third-quarter 2023, U.S. credit estimates saw the highest number of downgrades since the pandemic: an aggregate of 91 entities saw credit estimates lowered, with over 75% of these going into the ‘ccc’ category. Year to date, there have been a total of 61 upgrades and 175 downgrades, bringing the aggregate credit estimate upgrade-to-downgrade ratio to 0.35.
Middle-market collateralized loan obligations (CLOs) have seen strong new issuance this year, with year-to-date volume surpassing 2022 total issuance by end of July 2023. Through September, $18.38 billion of middle-market CLOs have been issued, versus $9.38 billion over the same period last year, an increase of 95%. Broadly-Syndicated Loan (BSL) CLO issuance over the same period is down 32.5% this year.READ MORE
Here are some ways our products can help private market participants.
Available for private equity, direct lending/mid-market and feeders, private debt and hedge funds plus real estate, infrastructure, VC funds and rated note structures.
For PE including NAVs, subscription facilities, secondary funds, collateralized fund obligations.
A confidential indication of the creditworthiness of an unrated company or portfolio of companies in an alternative fund, supported by a credit rationale report.
For alternative funds seeking feedback on the potential indicative ratings of hypothetical capital structure scenarios presented by their entity.
Provides private markets firms an assessment of sustainable financing frameworks or transactions at the firm level and/or for its alternative funds’ portfolio companies.
Provides private markets firms an assessment of the potential financial impact from a cyber incident at firm level and/or for its alternative funds’ portfolio companies.