Morningstar: Default rates rising among middle market issuers
Default rates are rising among middle-market issuers and further deterioration in overall credit quality is expected over the next year, according to a new report by Morningstar.
The firm said it has seen defaults within its private credit portfolio “double” over the past 18 months, with default activity among rated middle market issuers having “accelerated year to date”.
“Private credit defaults are now occurring at the highest rate since we began keeping records of private credit actions in 2019 as an expanding array of borrowers is facing the combined pressures of slower earnings growth and persistent high borrowing costs on cash flow,” the report said.
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“Rising default activity among our rated middle market issuers in the first half, in conjunction with a higher ratio of downgrade actions to upgrade actions, points toward further deterioration in middle market credit quality over the next six to 12 months,” added Michael Dimler, senior vice president, private credit.
Despite this, Morningstar said the private credit market still has “plenty of room for further growth”, with the global private credit market having already tripled in size over the past decade to exceed $1.8tn (£1.35tn).
It said that while there has been an “industry wide” slowdown in funding in recent years, institutional flows to private debt funds “remain solid”, having reached or exceeded $200bn in each of the last five years, with direct lending continuing to take the largest share of capital.
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“Looking forward, we believe for a variety of reasons that the private credit market has plenty of room for further growth, including that assets under management (AUM) in private credit remain multiples lower compared with those in private equity,” it said.
“Additionally, institutional investors continue to be attracted to private credit (particularly direct lending, which comprises the majority of private credit AUM), given that it adds portfolio diversification, has low correlation to public markets, and generates comparatively high risk-adjusted returns.
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“While those risk-adjusted returns get a boost from the absence of marked-to-market pricing, which raises some concerns, we expect this condition to persist due to the complexity associated with implementing a change to this approach.”
Morningstar said it expects well-established fund managers to continue to consolidate market share, with the top 10 raising nearly one third of total capital in 2024.
