“Compelling” opportunity for new capital in direct lending
The opportunity for new capital in corporate direct lending is “compelling”, as new loans have a far better outlook than existing portfolios, according to an asset management boss.
Rich Byrne, president of Benefit Street Partners, which manages around $75bn (£59.3bn) of assets across a range of credit strategies, said that the vintage of deals that underwriters are currently underwriting “will be looked back on as one of the best vintages ever”.
“It’s one of the best opportunities we’ve seen in years,” he told Alternative Credit Investor.
Read more: Benefit Street Partners raises $4.7bn for fifth direct lending fund
“For existing portfolios, you have to navigate higher defaults, but new loans have a completely different outlook.
“Legacy portfolios will experience very turbulent waters, whereas the new investments present an excellent opportunity.”
The direct lending market has boomed in recent years, as investors took advantage of the high-interest-rate environment to boost their returns.
But default rates are expected to rise as borrowers struggle to repay at higher interest rates.
Read more: Higher default rates loom for corporate direct lending
“We expect default rates to double, as they were running so low,” said Byrne. “Our forecasts put defaults between three and five per cent, up from the current level of less than two. However, by historical standards, this is still relatively low.
“Defaults may be back-end loaded as loans get closer to maturity. There was an enormous supply of new loans in 2021/22, and most of them were seven-year loans, so we still have four or five years left for any reckoning around that.”
Looking at the new vintage of loans, Byrne noted that sponsors are recalibrating for higher interest rates by putting in more equity.
Read more: Direct lending yields suggest resilience, says Brookfield Oaktree
“It’s hard to reverse-engineer up to the interest coverages you’d get when rates were near zero, but on average, a sponsor-backed deal in 2021 had an equity check size of around 40 per cent of the purchase price,” he said. “Today, that’s 60 per cent.
“Putting in significantly more capital creates much better credit quality. We’re getting better documents and better covenants.”
Higher default rates will lead to a greater differentiation in credit, Byrne added, with better managers poised to outperform.
“Previously, it didn’t matter as default rates were so low that everyone did well,” he said. “The market will start punishing underperforming credits.”
