Federated Hermes: Private credit default risk remains
Private credit defaults could still rise towards the end of the year, as borrowers continue to struggle with the higher cost of debt, Federated Hermes has warned.
Patrick Marshall, head of private credit at Federated Hermes, said that he expects the market’s default rate to increase “to a certain extent” in the second half of the year, echoing similar warnings made by analysts at the start of the year.
Since then, the relatively steady performance of private credit in the year to date seemed to have quelled fears of a cliff-edge of defaults. However, Marshall believes that some companies remain at risk.
“In the second half of the year, we anticipate that defaults will increase to a certain extent,” said Marshall.
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“Companies burdened with high levels of financial leverage will continue to struggle under the increased cost of debt putting pressure on debt covenants. Borrowers are further feeling the pressure of inflationary costs, reduced consumer spending and geopolitical risks all of which have an impact on financial performance.
“As a result, different forms of borrower restructurings will increase, especially for those funds that have lent with aggressive loan structures to cyclical companies.
“Fund raising will become more difficult for these funds as institutional investors including pension funds and insurers will continue to favour more conservative, income generating direct lending strategies, suitable for matching their liabilities, rather than higher risk strategies which have been negatively impacted by the current environment.”
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He added that some borrowers who have underperformed will struggle to find the liquidity to refinance their loans as they approach maturity, meaning that only the strongest and most stable companies will find it easy to access the market.
This may lead to the market becoming bifurcated with non-cyclical companies able to negotiate good loan terms and more cyclical companies being penalised in terms of cost of borrowing and tighter loan terms.
“2024 has been a great year for direct lenders who have been disciplined in their lending approach,” Marshall added.
“These lenders have been able to get strong yields on new loans and lender friendly protection rights in loan documentation whilst not having had to deal with restructurings in their portfolios.”
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