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“We’re focused on the fact that despite all the soft landing talk, we might have yet to feel all the profound impacts of historical rate hikes.”
– Adam Hetts, global head of multi-asset, Janus Henderson Investors.
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Four for '24 (Fourth of a Series)
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How to Stop Worrying About the Maturity Wall (Second of a Series) | |
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A recent report from KBRA’s research team (“Private Credit: 2024 Maturity Wall is a Myth”) outlined three conditions that need to exist for looming maturities “to present a challenge to the industry.”
First, there have to be a “significant” number of maturities coming up. Second, if lenders have to take losses as a result of their inability to successfully roll these loans, their losses have to “deplete substantial equity cushions” as a result. And finally, if borrowers’ owners “hand over the keys,” lenders must lack sufficient “infrastructure to extract value” from those companies.
From data comprising over 1,800 portfolio companies and $750 billion of private debt, KBRA estimates only 10-15% of their total loans come due in 2024 and 2025. The firm also analyzed the portfolios in the 27 BDCs it rates. Only 14% of those loans mature in the next two years. Nor is this information limited to private portfolio data. KBRA looked at the same information on all BDCs and came up with about the same figure – 16%.
They also note a Goldman Sachs study that points to a similar share of corporate borrowing maturing over the next two years. This research revealed a similar trend for investment grade and high-yield debt. Since 2008, the percent of corporate debt due within two years shrank from over 25% to around 15%. It also highlights how the duration of corporate debt has doubled over the past three decades, as cheaper terms made refinancing compelling for treasurers.
Beyond 2025, as our Chart of the Week highlights, the level of maturing private loans begins to rise, peaking in 2028 and 2029. Of course, CFOs don’t sit still and let their debt come due without a fight. Indeed, by the very nature of private equity owned businesses, it’s rare debt that reaches its final payment date without being refinanced or the company sold.
As we discussed last week, the maturity walls don’t sit still either. They act like sand waves marching towards the beach, propelled by the tidal forces of refinanced loans. What looks like imposing cliffs, eventually smooth out over time, eroded by the steady flow of capital into leveraged lending.
Unlike the pre-GFC era, this cash stream is increasingly coming from the influx, not just of new CLO vehicles, but from institutional (and increasingly, retail) investors in private credit. In the world of asset management, these investors aren’t motivated solely by rates or ratings. They choose managers based on superior track records demonstrating the ability to generate quality assets at consistent premium yields over long periods of time.
We predict that the dynamics driving private credit investing will have a salutary effect on leveraged loan volatility, including the predictability of maturity walls. Next week we’ll compare today’s outlook with how markets came to worry about loan repayments in the first place.
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New: Private Capital Call Podcast
Episode 3: Mickey D. Levy, Macro Economist
"I believe the U.S.’s favorable characteristics will lead it forward and I remain positive." - Mickey D. Levy
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The bulk of private debt doesn’t start maturing until 2027, peaking in 2028. | |
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Source: KBRA DLD
(Past performance is no guarantee of future results.)
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February 6 & 7, 2024
Encore at the Wynn in Las Vegas, NV
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SFNet’s Asset-Based Capital Conference 2024
Doing What We Do Best
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30-DAY FREE MEMBERSHIP
Join the leading voice of the middle market. Try us free for 30 days.
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ESG’s return impact downgraded | |
Investors overall appear to have less faith in ESG’s transformative characteristics in the long term, especially those based in the US. | |
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After a period of heightened focus on environmental, social and governance issues, LPs have begun to recalibrate their ESG strategies amid escalating political pushback against such initiatives, particularly in the US.
Only 59 percent of LPs believe a strong ESG policy will lead to better long-term returns in their private markets portfolios, according to Private Debt Investor’s LP Perspectives 2024 Study (see chart). This marks a decline from 69 percent in last year’s study and 74 percent two years ago.
Notably, LPs in North America exhibit the lowest level of confidence in the potential of ESG, with just 41 percent saying a strong ESG policy can improve long-term financial returns, in contrast with 60 percent of respondents in the Asia-Pacific region and a robust 79 percent in Western Europe.
In the US, the subdued optimism surrounding ESG comes at a time when the anti-ESG movement is gaining traction among the more conservative states. For example, Florida governor Ron DeSantis passed a resolution in 2022 that prohibited
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state funds from taking ESG factors into account in their investment process.
In Idaho, state entities engaged in investment activities are barred from prioritising ESG characteristics. Meanwhile, in Missouri, secretary of state John Ashcroft issued a rule in June that requires broker-dealers to obtain investor consent before allocating funds to investments with non-financial objectives.
Yet in the more liberal states, some LPs have been showing a growing appetite for ESG investments. In its November board meeting, the California Public Employees’ Retirement System shared plans to double its climate-focused allocations to $100 billion by 2030. The pension also plans to triple the size of its ESG investment team to 15, affiliate title Responsible Investor reported in November.
“In the US, [ESG] is a polarised issue, but you are starting to see that breakthrough for the first time,” said an investor from a fund of funds during an LP panel discussion at the Impact Investor Summit: North America 2023 held by affiliate title New Private Markets in October.
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Leveraged Loan Insight & Analysis | |
BDC portfolio marks edge higher in most recent quarter* | |
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*Based on universe of BDCs that have reported 4Q23 earnings as of 2/13/24
BDC earnings season is in its early stages, with the vast majority of funds still yet to file. However, taking a look at the 16 BDCs that have published their 4Q23 results as of February 13 shows that portfolio loan valuations have edged higher overall, as hopes of an economic soft landing increased and credit spreads tightened. For the universe of BDCs that have reported 4Q23 earnings, roughly two-thirds of them posted an increase in net asset value per share.
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The weighted average mark on debt holdings increased to 96.61% from 96.49% in the prior quarter. Digging deeper, marks climbed modestly across the risk spectrum, with first-lien debt increasing by 6bp to 97.25%. and second liens gaining 8bp to 92.65%. At the fund level, 10 out of the 16 BDCs saw the weighted average mark on their debt portfolio move higher in 4Q23. From a credit quality perspective, the weighted average non-accrual rate for this early reporting cohort remained low but increased to 2.09% in 4Q23 from 1.89% in 3Q23. Notably, there is a considerable variation in non-accrual rates across this universe of BDCs. | |
The Pulse of Private Equity | |
Over the long term, PE growth and buyout have been standout performers. VC was keeping pace but has retrenched since 2021. | |
This assumes investing in our universe of funds for which we have cash flows and net asset value (NAV) data available each quarter. It is a hypothetical result if one were able to invest in a “market” portfolio of funds starting, in this case, at the beginning of 2007. We use our quarterly returns series available in our PitchBook Benchmarks report to calculate the growth in asset value. This data also constitutes our Private Capital Indexes. Actual results experienced by limited partners will vary widely. | |
KBRA Direct Lending Deals: News & Analysis | |
TTM Default Volume, Count | |
Middle Market & Private Credit | |
Fitch’s Privately Monitored Middle Market Portfolio Overview, 4Q23 | |
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In the charts above, Fitch presents aggregate data for MM companies, defined as in the area of $500 million of debt or $100 million of EBITDA or below, that it privately rates for asset managers.
• Interest coverage (EBITDA/interest) is estimated to have declined to 1.6x in 2023 as a full year of increased rates and refinancings done at higher spreads fully flowed through income statements. In the high interest rate environment, interest coverage takes the spotlight as elevated interest payments can quickly exhaust liquidity for lower rated issuers. However, the utilization of PIK structures has become increasingly common within the private credit market, and has alleviated the cash interest burden for some issuers in Fitch’s portfolio. Historically, coverage had fluctuated in the 2.5x range before the
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current Fed’s tightening cycle, through which coverage peaked at around 2.7x in 2021 before declining to 2.2x in 2022 and further in 2023.
• Revenue growth is estimated to have moderated to 7.2% in 2023 after two strong years of double-digit growth, albeit on a lackluster 2020 due to the effects of the pandemic. Fitch expects a continued moderation in revenue growth to the midsingle digits for 2024.
• The median EBITDA margin in Fitch’s PMM portfolio shifted upward to 16.8% in 2023 from 16.1% in each of the prior two years as the lagging effects of the pandemic transitioned to the rearview mirror and operating conditions eased over 2023.
Learn more
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Synergies & Cost Savings EBITDA Addbacks (Capped vs. Uncapped vs. None Allowed) | |
High-Yield Bond Statistics | |
Weekly fund flows source: Lipper | |
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The blue line in the chart is the current dividend yield of the *VanEck BDC Income ETF (currently at 10.9% as of 2 February, down from the highest level in last 12 months of 12.1% in May 2023) that tracks the overall performance of publicly traded business development companies (BDCs, lenders to privately held middle-market businesses that tend to be below investment grade or not rated, with most lending comprising of senior secured loans). The brown line displays the BofA Merrill Lynch US High Yield (US HY index - currently at 7.6% as of 2 February, decline from the highest level in last 12 months of 9.5% in October 2023), which tracks the performance of USD denominated below investment grade corporate debt publicly issued in the US.
On 31 January, FED kept the interest rates unchanged (5.25%-5.5%), indicating no rate cuts unless inflation target of 2% is met (3.4% in December 2023). With significant spread between the inflation target and the actual (140bps), we expect the rates to remain unchanged in the upcoming March meeting.
The spread of BIZD dividend yield minus the US High Yield (shaded area in gray) shows the premium/discount of middle-market loans over traditional high yield. As of 2 February, BIZD dividend yield was at a premium of 330bps to the US High Yield Index, 71bps above the 1-year average of 259bps. The premium for middle market, to some extent, depicts illiquidity for private loans and the credit risk associated with middle market companies. The spread of BIZD dividend yield minus the 2-year treasury (shaded area in light blue) stood at 653bps as of 2 February, above the 1-year average of 636bps.
*As of 31 January 2024, BIZD’s weighted average market cap stands at USD 4.8bn, with PE ratio of 9.1 and PB of 1, with the entire portfolio holdings in publicly traded BDCs. Click here for top holdings.
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Private Debt Intelligence | |
GPs target APAC’s emerging private debt market | |
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APAC’s nascent private debt market is witnessing significant growth, with the amount of capital targeted by direct lending funds rising to $11.7bn from 45 APAC-focused vehicles at the end of 2023, up from $7.3bn by 40 funds at the start of the year, according to Preqin data.
APAC represents a dynamic growth opportunity for private debt investors, as markets in North America and Europe become more mature. However, despite the increased competition, private debt remains an attractive asset class for investors, with 90% of LPs surveyed by Preqin saying the asset class had met or exceeded expectations in 2023. They are also optimistic about the future, with 45% expecting private debt to perform better in the coming 12 months, compared with just the 9% that expect weaker performance.
For more, read Preqin’s Insights+ report: Private Debt Q4 2023: Preqin Quarterly Update
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Middle Market Deal Terms at a Glance | |
This publication is a service to our clients and friends. It is designed only to give general information on the market developments actually covered. It is not intended to be a comprehensive summary of recent developments or to suggest parameters for any prospective financing opportunity. | | | | |
