Morningstar - Q2 2022 - 25

Private Debt Market
Poised for Growth
After seeing its resilience tested as never
before during two years of pandemicrelated
disruptions, the private debt market is
poised for growth as yield-hungry
institutional investors extend their hunt for
high-performing assets.
Public health lockdowns in 2020 dealt a series of
blows to borrowers, pushing default rates
higher and creating new debt repayment
challenges to both private and public companies.
Central bank stimulus programs limited the
damage and helped private debt withstand the
effects of the economic downturn.
U.S. default rates for private loans peaked at 8.1%
in the second quarter of 2020 before falling back
to 1.04% in the fourth quarter of 2021, according to
the Proskauer Private Credit Default Index.
The rise of private debt is being driven by investors'
search for higher returns in a prolonged period
of low interest rates and recent stock market
volatility. Institutional investors are turning away
from more traditional assets to take advantage of
the returns offered by private debt.
" There is an increasing trend of rotating a small
portion of your fixed-income portfolio into direct
lending funds, " says Jess Larsen, the founder
and chief executive at Briarcliffe Credit
Partners, a dedicated private credit placement
agency, noting that investors were disappointed
by the dwindling returns delivered by
traditional fixed income.
Last year was a banner year for private debt, with
money dedicated to the asset class hitting
$191.2 billion, the highest annual sum since 2017,
according to PitchBook, a Morningstar company.
115.6
In one sign of investor confidence in the continued
strength of the strategy, Blackstone BX amassed
$32.6 billion for its new private credit fund in
2021, which mainly invests in first-lien loans. Also
in 2021, Ares Management raised $8 billion
88.5
75.4
60.9
2011
2012
2013
2014
Source: PitchBook. Data as of 12/31/2021.
2015
2016
2017
2018
2019
2020
2021
for an oversubscribed direct lending fund, almost
double the sum it had first targeted.
Two of the largest U.S. pensions-the nearly
$482 billion California Public Employees'
Retirement System and the $320 billion California
State Teachers' Retirement System-both stepped
up their private credit allocation in 2021. As
part of a new four-year plan, CalPERS set up a 5%
private debt allocation target, alongside other
moves to increase its exposure to alternative
assets, as the pension manager struggles to meet
its investment-return target of 6.8%. CalSTRS also
added a 5% target allocation to private credit
as part of its 13% fixed-income allocation, according
to a July report from the pension manager.
Meanwhile, credit managers such as Barings
BDC, Golub Capital, PGIM Private Capital,
and Benefit Street Partners announced a record
amount of private debt origination, fueled
by the acceleration in mergers and acquisitions in
recent quarters. Despite the optimism, private
lenders are monitoring threats to the borrowing
market, including rising interest rates and an
increase in inflation. As rates rise, the floating-rate
structure that many private credit instruments
use offers investors the promise of more returns
but would also increase costs for borrowers.
Some credit market specialists say that even a
series of rate hikes over the next two years
would still leave prevailing rates at relatively
modest levels.
" The Fed is signaling at least a 1% rate increase
this year, with analysts predicting another 1%
hike in 2023, " says Randy Schwimmer, co-head of
senior lending at Churchill Asset Management.
" That gets us to a 2% or so fed-funds rate by
the end of next year, still modest compared to the
5.5% we had in June 2007. We have a long way
to go before we're at the level of higher interest
rates before the 2008 financial crisis. "
Data on interest coverage ratios, which measure
a company's ability to pay interest on its debt
and is one of the primary measures of risk
in private debt markets, suggests that borrowers
on average are in better shape to withstand
higher interest payments than in the 2007-08
financial crisis, says Ian Fowler, co-head of Barings'
Global Private Finance Group.
" Back then, your average interest coverage ratio
was around 2 times, and today just looking
at our portfolio, the average interest-rate coverage
is 3 times or north of 3 times, which gives
companies more cushion to support higher interest
rates, " Fowler says.
Madeline Shi is a senior financial writer at PitchBook News.
Private Debt Fundraising Picks Back Up Capital raised by private debt managers
reached $191.2 billion last year.
Amount Raised
$250B
201.7
175.5
156.9
125.6
185.8
170.5
191.2
50
100
150
200
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Morningstar - Q2 2022

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