The private credit market is booming thanks to a higher interest rate environment and challenging equity markets, and investors are keen to increase their private credit allocations in 2024.^[1] That said, rapid growth, coupled with a lack of transparency with only 20% of private credit issuers being rated, has put a focus on the burgeoning risks.

There is Cash to Deploy

After years of strong fundraising, private credit funds had amassed more than $400 billion in dry powder globally as of September 2023. With challenging public markets, borrowers have been looking for other sources of funding to meet upcoming maturities. Broadly syndicated loan issuance in the U.S. and Europe is down nearly 30%, to its lowest level since 2010 (at $318 billion). Meanwhile, 'CCC' bond issuance has fallen to its lowest level since 2008 (around $2 billion). Private credit is looking to take up some of the slack as upcoming maturities of nonfinancial corporate debt rated 'B-' and lower in the U.S. and Europe are projected to double to $169 billion in 2025, from $83 billion in 2024.^[2]

In the U.S., private credit is growing its capacity through nontraded business development companies, interval funds, and middle-market collateralized loan obligations. Direct lenders have tended to target traditional middle-market borrowers with $25 million-$100 million (or equivalent in euros) of EBITDA, but the growing trend for club deals has extended private credit's reach to larger and more diverse borrowers. Additionally, distressed and special situation funds – which represent as much as one-third of available capital – are waiting in the wings for rescue financing opportunities.

According to the Proskauer Private Credit Survey 2023, European private credit vehicles are less diverse than in the U.S., with a greater focus on direct lending and special situations.^[3] Still, innovations adopted in the U.S. are finding space in some European markets. The private credit market's growth has been spurred on by over a decade of easy money and a search for yield, and assets under management (AUM) have quadrupled in the past 10 years.

But Default Risks Raise Concerns

Rapid growth in a market where it can be tricky to benchmark the risk and thus the price of loans, alongside macro headwinds that are contributing to increased downgrades and defaults, have raised concerns among market participants and regulators alike. As a result, institutional allocators who often quantify the risk of public fixed income in accordance with renowned credit assessment methodologies, are sponsoring the evolution of a market best practice where the same transparent and rigorous assessment criteria can be extended to illiquid fixed income exposures, allowing for greater balance sheet consistency and a clearer view on relative risk across their credit portfolios.

Further, with new entrants crowding the non-bank lending landscape and heightening both fundraising and deal flow competition, the ability for private credit GPs to deliver gold standard LP reporting whilst simultaneously ensuring timely decision-making can be achieved is imperative. At a time when volatile market conditions, riskier borrower profiles and general concerns around illiquidity premiums are complicating the risk-reward balance, efficient, accurate, and comprehensive risk management practices are needed to support:

• Prospecting and initial assessments of deals and borrowers across sectors and countries.
• Peer group comparisons and relative benchmarking
• Credit risk pricing and ongoing portfolio surveillance
• Early warning detection of potential defaults.
• Stress testing and scenario analysis.
• Inclusion of new climate-related risks.

Investors Look to Dig Deeper on Vulnerabilities

Tighter financing conditions will test financial vulnerabilities. S&P Global Ratings expects policy interest rates to only start easing in the second half of 2024, putting pressure on middle-market borrowers that have already been struggling to generate positive free operating cash flow.

Inappropriate risk assessments can have significant impacts, resulting in lower than optimal returns or forcing borrowers to the wall. Institutional allocators increasingly expect credit assessments completed by General Partners to be conducted in alignment with recognized and understood methodologies and for reporting to incorporate benchmarkable credit scores.

A Host of Cutting-edge Solutions Aid Analysis

S&P Global Market Intelligence offers a wide array of credit risk management tools to help both General Partners and LP investors navigate today’s market complexities. Two of these include RiskGauge^TM and the Corporate Credit Assessment Scorecard that can be used for your Direct Lending and Alternative strategies

RiskGauge^TM enables users to assess the credit risk of over 50 million public and private companies with business credit risk reports that leverage cutting-edge analytical models and credit scores,^[4] robust private company data, company firmographics, relative performance benchmarks and rich, insightful commentary. Climate RiskGauge extends this to enable users to evaluate the impact of climate-related scenarios on their portfolios to better understand the possible risks and opportunities that may arise on the journey to a low-carbon economy.

The Corporate Credit Assessment Scorecard is an easy-to-use tool that draws on a mixture of quantitative and qualitative questions in a check-box style to identify key risks in a consistent and repeatable way. It is fully transparent providing the underlying logic and generating letter grade credit scores that are globally applicable, broadly aligned with S&P Global Ratings’ criteria and supported by historical default data back to 1981. The Scorecard is especially useful for low-default portfolios that, by definition, lack the internal default data necessary for the construction of statistical models that can be robustly calibrated and validated.

For more information on our private credit solutions contact us here.