The scale of the corporate restructuring needs globally “could exceed the previous peak seen after the 2008 global financial crisis”, according to a recent note from BlackRock.
The asset manager’s research arm, BlackRock Investment Institute, says this is due to the rising pile of sub-investment grade debt, which has more than doubled to USD5.3 trillion outstanding since 2007.
“Private credit has been an especially fast-growing segment, expanding to USD850 billion by financing companies that would previously have looked to banks or the public high yield market.”
BlackRock explains that many companies issued debt to take advantage of low borrowing costs, which then left many vulnerable as their revenues have come under pressure from Covid-related disruptions.
“It creates opportunities for restructuring and distressed debt specialists, an important subset of the private credit market. Many institutional investors remain under-invested in the growing private markets, we believe, and may be underappreciating their ability to take on liquidity risk.”
Fund managers have followed the trend by seeking to raise record amounts of capital in the private debt market, with data from Preqin showing an aggregate USD295 billion was targeted by funds in the third quarter of 2020.
This is a 54 per cent increase compared to January 2020. The number of funds in the market also grew by 19 per cent over the same period, from 436 to 521.
Preqin writes in its recent quarterly report that one of the key drivers of fundraising activity across the private debt space has been the yield spread over 10-year government bonds, which have made private debt investments attractive on a relative basis.
Direct lending vehicles are the dominant strategy, but distressed debt strategies now account for 13 per cent, looking to target investors as they move up the risk curve in search of higher returns.
BlackRock’s researchers warn that supportive fiscal and monetary policies have helped large companies to raise capital and borrow on the public market, but smaller firms have lacked the same access.
“Many companies will likely have to evolve their business models as the pandemic accelerates long-term structural trends such as digitalisation. We see this creating a wave of restructurings – and room for private credit to cater to smaller and lower-credit quality issuers,” writes BlackRock.
After the Global Financial Crisis in 2008, creditors tried to avoid losses from defaults and restructuring by elevating the seniority of the debt in the capital structure, and investors bought up discounted loans and bonds in the secondary market.
“The Covid shock has hit many companies funded by such loans, but the borrower-friendly terms could mean fewer outright defaults and opportunities for private credit investors to step in to provide fresh capital.”
The firm notes the recent prevalence of “covenant-lite” agreements, which put fewer restrictions on the borrower and offer less protection for the lender, and accounted for three quarters of US leveraged loans at the end of 2019, according to Moody’s.
“We see a historic opportunity for the private markets to fund post-Covid corporate restructuring. We see a case for a greater share of private market allocations to be in private credit than we typically observe in clients’ portfolios.”
“We see potential for such investments to serve as growth assets and diversifiers when new sources of portfolio resilience are needed,” BlackRock concludes.