In the face of deteriorating economic conditions and a tighter financing environment, the private credit market is facing its first big test, says Moody’s Investors Service.
A report from the rating agency said the factors that underpinned strong growth of private credit in recent years have shifted dramatically, resulting in higher interest rates and slowing economic growth. Private credit is now facing constrained liquidity and declining asset performance, which is expected to boost defaults.
“With monetary policy tightening, economic growth stalling and less capital flowing into risk assets, there are likely to be rising defaults among private credit borrowers,” the report said.
At the same time, the tighter financial and economic conditions are expected to curtail the flow of capital into private markets, Moody’s said: “Higher yields on traditional fixed-income assets will create more competition for private credit.”
Increased market volatility will limit the amount of capital that pension funds and other institutional investors can direct to private assets, it said, and the reduced risk appetite of high-net-worth investors will also weigh on private credit allocations.
Additionally, the report said weakness in private equity markets will spill over to private credit.
“Market uncertainty and higher interest rates are complicating [private equity’s] ability to exit existing investments and deploy capital into new [leveraged buyouts],” it said. “A slowdown in [private equity] activity will hurt private credit managers that rely on [private equity] for new loan supply as well as to provide exits for loan repayments through an IPO, sale or refinancing.”
Despite the increased pressure on the sector, managers with more scale will “fare better than others in tighter markets,” the report said.
“Private credit is here to stay and there will be growth opportunities for those with significant dry powder — barring a very severe default cycle or substantive regulatory changes,” it said.