“This is not a time to be complacent” in private credit
Global macroeconomic uncertainty means that “this is not a time to be complacent” for the private credit industry, James Charalambides of Adams Street Partners has warned.
The asset manager’s head of European private credit noted “uncertainty, inflation risk and recession risk” that make it increasingly important to pick the right manager.
“If you look at private credit returns over long time frames, you see a lot more disparity in returns between managers during a downturn in the cycle,” he told Alternative Credit Investor.
“To be able to perform well through cycles, being able to hunt from a large deal pool and be very selective becomes critical.”
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However, Charalambides also highlighted that private credit is “very well suited to this kind of environment” due to its ranking in the capital structure and approach to lending.
“We’re top of the capital structure, typically making low LTV loans to high-quality borrowers, with tight controls in private loan documentation through covenants, so you get a lot of downside protection,” he said. “Additionally, virtually everything we do is floating rate loans, so you’re not taking interest rate risk. These are investments that should perform well, especially if you have a good credit selection through cycles, so at the same time you’re getting pretty compelling returns.”
Some industry onlookers have raised concerns about rising default rates in the sector and a lack of transparency which can make it challenging to ascertain the true health of a portfolio.
Tools such as payment-in-kind (PIK) interest and amend-and-extend agreements can be used to effectively ‘kick the can down the road’ when it comes to declaring defaults.
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Charalambides said that PIK is one of the statistics that Adams Street monitors, and has seen an uptick in its usage of late.
“Sometimes, there’s good reason to have a deal structured with PIK interest,” he said. “You might do it deliberately to create flexibility for the business to invest where they get high returns on those investments, and there’s a good alignment of interest between lenders and equity holders. However, in other cases it can be a sign that borrowers are under pressure to repay their loans.
“We have seen the percentage of PIKs increase over time. Currently we think it’s around eight per cent for the broader market. If we look at our own portfolio across all of our investments in US and Europe, we’re very significantly below that level.”
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Adams Street focuses on the core mid-market, which it defines as companies of an enterprise value of $150m (£111.5m) to $750m.
Charalambides said that these companies tend to be more resilient with better performance than those in the lower mid-market, which tend to pose more credit risk in a downturn.
