Private credit under strain as troubled loans swell

{"text":[[{"start":9.8,"text":"Strain is spreading across private credit portfolios, with some of the largest funds taking writedowns and warning about problem loans as the industry faces its biggest challenge in almost a decade."}],[{"start":21.6,"text":"The value of troubled loans held by some of the biggest private debt investors has reached levels last seen in 2017, when the industry was dealing with a hangover from an oil price crash, an FT analysis of figures from fixed-income data provider Solve has found."}],[{"start":37.84,"text":"Loans placed on non-accrual status by the 20 largest publicly traded business development companies (BDCs) — listed funds that invest in private credit loans — climbed to a median 2.8 per cent of their cost in the second quarter, up from 2 per cent at the end of March."}],[{"start":53.52,"text":"The non-accrual demarcation is one signal of stress in the private credit industry, indicating borrowers have either stopped making payments on their loans or that a fund believes a borrower may soon default on its obligations."}],[{"start":66.26,"text":"David Golub, co-chief executive of private credit investment firm Golub Capital, told investors earlier this month that there was “elevated credit stress” as the industry grappled with a rise in defaults and problem loans."}],[{"start":78.44,"text":"“We’re in a credit cycle,” Golub said. “Others denied it for a while. I don’t think there’s a lot of denial any more.”"}],[{"start":null,"text":"

"}],[{"start":86.24,"text":"Analysts at Fitch Ratings last week warned that private credit defaults had hit a new record in July. Separate data from PitchBook LCD showed the biggest publicly listed BDCs shrank again in the second quarter as funds were hit with impairments and as sales and repayments of loans outpaced commitments on new deals."}],[{"start":104.92,"text":"Listed vehicles managed by KKR and Blue Owl, as well as one run by Apollo Global known as MidCap Financial, were among the funds in which repayments outstripped new lending in the quarter, with executives at KKR pointing to limited dealmaking and its push to exit certain loans."}],[{"start":121.2,"text":"The firm’s listed fund, FS KKR Capital Group, reported that 7.1 per cent of its loan book was troubled in the second quarter, a slight improvement from the prior quarter but still far above the industry average."}],[{"start":133.4,"text":"The figures underscore the challenge facing the private investment industry, which wagered heavily on private credit as a major source of growth as it looked to invest money for insurers, retirees and wealthy individuals."}],[{"start":145.32,"text":"The rapid ascent of these vehicles and the lucrative management fees they throw off sent valuations of groups such as Blue Owl, Ares Management, Blackstone, Apollo and KKR soaring. But a deluge of outflows as private credit returns swooned has weighed on the cohort’s shares."}],[{"start":163.04,"text":"Industry titans have acknowledged that after a long period of relatively muted defaults, bankruptcies and restructurings were beginning to move back towards their long-term average."}],[{"start":171.84,"text":"“We are . . . conserving our capital, maintaining ourselves in a more defensive and risk-averse posture,” said Armen Panossian, the co-chief executive of Oaktree’s credit arm. “We really want to be able to lean into the market on the back of what we think will be more volatility . . . Beneath the surface, there’s cause for concern.”"}],[{"start":191.28,"text":"But many executives across the $2tn asset class believe that the alarmism surrounding private credit’s troubles is overblown, with several blaming the media — including the FT — for the outflows weighing on the asset class."}],[{"start":null,"text":""}],[{"start":203.86,"text":"On earnings call after earnings call, senior leaders said most of the loans they underwrote continued to perform well and that the earnings of the average business they lent to were growing."}],[{"start":214.18,"text":"Craig Packer, Blue Owl’s co-president, told investors in one of the firm’s funds that “credit metrics are healthy and the issues we are managing remain isolated.”"}],[{"start":223.12,"text":"Jim Miller, who runs Ares’ US direct lending business, said borrowers were in “solid” shape, noting that “interest coverage and leverage levels were generally consistent with our five-year average.”"}],[{"start":233.98,"text":"Some of the optimism belies the complicated picture ahead for the private credit industry, which collectively holds thousands of loans to businesses across the globe. While software companies, which account for a substantial portion of BDC portfolios, have reported revenue growth, it is unclear how durable that growth will be as corporate spending shifts to AI."}],[{"start":251.92,"text":"Much of the pain already seen has been centred on investments the funds helped finance between 2020 and 2021, when interest rates were near zero and private equity groups went on a buying binge while valuations were elevated."}],[{"start":267.86,"text":"Many of those companies are now struggling to service their debt as interest rates have climbed, with executives on earnings calls repeatedly pointing to that cohort as the source of trouble."}],[{"start":278.54,"text":"Higher borrowing costs have “starved some businesses from investing”, said Bryan High, head of Barings’ global private finance team. “They are using all the cash they are generating to pay interest to lenders and so growth for some businesses wasn’t as strong as it could be.”"}],[{"start":294.38,"text":"During the quarter, lenders including Blackstone and KKR marked down the value of a loan they had extended to software group Medallia. Private equity firm Thoma Bravo had turned the business over to lenders earlier in the year, throwing in the towel on a $5bn equity cheque. Blackstone’s fund marked the investment at less than 50 cents on the dollar at the end of June, down from 60 cents in March."}],[{"start":null,"text":""}],[{"start":317.94,"text":"Ares’ fund wrote down the value of its loan to the human resources software company Cornerstone OnDemand, while lenders including Blackstone and KKR took over dental services company Affordable Care after it defaulted on its debt."}],[{"start":332.3,"text":"The weakness has been captured by the drawdown in BDC share prices, with listed BDCs managed by KKR and BlackRock down more than 15 per cent over the past year. The fund managed by Apollo has lost 14.5 per cent for investors over the same period."}],[{"start":348.72,"text":"Others have rebounded from their lows and are either back in the green or flirting with a positive return, including funds managed by Goldman Sachs, Ares and Golub."}],[{"start":358.2,"text":"Some firms, including BlackRock, have restructured their portfolios. The firm’s vehicle, known by the ticker TCPC, sold a $523mn block of loans in a bid to shore up its balance sheet. Executives said they had hired bankers to explore options for the vehicle’s future, which could include selling off its assets and winding it down."}],[{"start":379.88,"text":"Others, including KKR’s troubled vehicle, have waived some incentive fees."}],[{"start":383.84,"text":"Mitchel Penn, an analyst at Oppenheimer, noted that the sell-off in BDC share prices meant funds were “priced for death”. His own research showed that on average over the past five years, funds in the bottom quartile were generating returns on equity below the yield on a 10-year Treasury."}],[{"start":384.34,"text":"“Underwriting wasn’t as good as it should have been,” he said. “They weren’t as picky.”"}],[{"start":408.61,"text":""}]],"url":"https://audio.ftcn.net.cn/album/a_1786961950_6716.mp3"}