Borrower defaults could create attractive lending opportunities, says Pimco
40 per cent of private credit borrowers are not producing enough cash flow to service their debt, which could lead to attractive new financing opportunities, according to Pimco research.
The asset manager said that private corporate credit is heavily concentrated in sectors such as technology and health services, which are susceptible to AI disruption and changing business conditions.
“These are typically smaller, leveraged companies financed with floating-rate debt, making them vulnerable to sustained high interest rates, economic slowdowns, defaults, and lower recoveries,” Pimco said.
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Citing data from Lincoln International, Pimco said that the proportion of borrowers with fixed charge coverage ratios below 1x has risen from 15.9 per cent two years ago to 40 per cent this year.
“This means 40 per cent of private credit borrowers (size weighted) are not producing enough cash flow to service all debt, taxes, and capital spending needs,” Pimco said. “If interest rates stay elevated for longer or economic growth slows, these borrowers would be more vulnerable to further increases in leverage, declining credit quality, and higher expected losses. Such a credit cycle would likely create attractive opportunities to provide new financing with preferable terms to new investors.”
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A subdued private equity market has created challenges for private credit as the majority of direct lending is sponsor backed.
Additionally, competition is hotting up with new entrants into the space, alongside the recovery of the broadly syndicated loan market.
“Balancing the risks and costs against potential investment returns within private markets more broadly, we see many attractive options for investors who can manage around illiquidity – but careful selection within sectors and companies is key,” Pimco said.
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