Morningstar warns of risks due to private debt fundraising slog
The difficult fundraising environment is creating risks for debt issuances by funds that are ramping, according to Morningstar DBRS.
The credit rating agency has warned that there is uncertainty around the analysis of feeder fund debt during the fundraising period, as the investment pool is not yet known. Feeder funds are typically used to bring capital into funds by issuing delayed draw debt while calling in equity commitments to funds.
Challenges in fundraising may result in less diversified portfolios, because managers will not be able to hit targets; increased uncertainty regarding a fund’s composition, due to longer timelines; and increased pressure on new and emerging managers, who may struggle to attract capital.
“The analysis of the collateral pool and the expectations around a manager’s ability to fundraise are based on assumptions that are supported by a manager’s track record and the assessment of predecessor funds, among other factors,” the analysts noted. “As fundraising timelines are extended, so is the period of uncertainty around fund size, composition, and diversity.”
Read more: Emerging ‘bifurcation’ of quality in middle market private credit
According to PitchBook, private debt funds raised $170bn (£134bn) over the trailing 12 months through the first quarter of 2024, down 31 per cent year-on-year. In the first three months of the year, there were only 25 funds, which raised $30bn in capital, compared with 28 funds that raised $43bn in Q1 2023. This was the weakest fundraising quarter for private debt funds since 2016.
Although a pick-up is expected, the analysts noted that “concerns remain regarding the increased risks associated with fundraising, especially for newer managers or smaller funds”.
Among the 25 funds that closed in the first quarter, only three were raised by emerging managers.
Morningstar DBRS’ analysts also pointed out that as funds grow larger, it will take longer for managers to hit their targets. The median time to close is now 19 months, the highest it has been on record.
“From a credit ratings perspective, this increasing uncertainty is included in our analysis in various ways, including conservative assumptions fund composition, lower credit quality expectations, and an acute focus on manager quality,” they noted. “With the majority of capital going to established managers with track record, manager selectivity is critical.”
Read more: Uptick in lower-mid-market borrowers struggling to meet covenants
Read more: Morningstar: Weakest private credit issuers will struggle this year