Private credit market reports few ripples from Signa fallout

JULIUS Baer’s decision to exit the private debt business is unlikely to prompt similar moves across the financial sector. But, market watchers said that greater caution is inevitable as the impact of Signa’s collapse continues to unfold.

Private debt products may face greater scrutiny, and lending rates may rise. Focus may also shift to new markets.

When European luxury property group Signa filed for administration late last year, Julius Baer was among the banks flagged for exposure. There are reportedly over 100 others, not including various insurers and asset managers.

Competition has been stiff among lenders, as non-bank players crowded in while corporate demand flagged. Those dynamics allowed Signa – and many other companies – to pile on unsustainable debt loads. Signa’s woes are centre stage, but there is plenty of pain in the periphery.

The European Central Bank has said that the region’s commercial property sector could struggle for years.

Separately, a BofA Securities report noted that privately held US high-yield bonds with ratings of single-Bs and triple-Cs recorded an overall default rate of 7.7 per cent last year.

Oleg Melentyev, head of high-yield credit strategy at Bank of America Merrill Lynch, said that this segment is a “good proxy to the private credit space since both carry very similar fundamental characteristics, including gross leverage at close to six times”.

Sponsors were willing to support their portfolio companies through the pandemic, he said, and defaults in the private space were below the overall high-yield market.

“A different dynamic has played out since early 2022, where private defaults have started to pick up ahead of the broad market,” he added. Coupons are also on the rise.

Swarup Gupta, industry manager and lead analyst, financial services, at the Economist Intelligence Unit, said that the Julius Baer episode is a “cautionary tale that illustrates both the allure of private debt and its potential pitfalls”.

“Demand for private credit remains high and will remain high until policy rates decline, but the Julius Baer-Signa episode represents another challenge for Swiss financial sector regulators following the Credit Suisse debacle,” he added.

Gupta expects tougher regulations from the Swiss government – in line with a pattern playing out around the world.

Government clampdowns on private lending means that higher-risk activity has petered out, said one Asian credit specialist at a private bank. Specialised private debt players, however, are still active. “This space existed for years and it will continue to exist,” he said.

There is sufficient appetite among non-bank players to extend credit – provided the loans are in the right segment, and to appropriately leveraged borrowers.

Of the 500 investment professionals polled by Natixis Investment Managers for its Natixis 2024 Fund Selector Outlook Survey, 57 per cent were bullish on private debt.

Among the 74 per cent whose firms are invested in private debt, 85 per cent plan to maintain or add to their holdings. In Asia, 46 per cent said that they would increase their allocations. The survey was conducted in November and December last year.

First Eagle Investments, which manages a number of investment funds, said in a note last month that the “leveraged-buyout space may be thawing”. More deals will mean more demand for funding, which it expects to support.

Its First Eagle Alternative Credit team is focusing on companies in the United States with annual earnings before interest, taxes, depreciation and amortisation of US$10 million to US$75 million – a space with growth and improving valuations.

In the Asia-Pacific, Sanket Sinha, global head of asset management at wealth manager Lighthouse Canton, said that he is “bullish on private debt as an asset class”.

Headquartered in Singapore, Lighthouse Canton last month said that it would work with Korea’s NH Group to co-invest in the Indian private debt space.

“Private debt has seen double-digit growth in the region, exceeding 20 per cent on an annualised basis over the last five years,” Sinha said.

“We find India, Australia and South-east Asia as interesting markets for private debt. As yields in the public markets start to fall, we expect that income-seeking investors will find private debt more attractive.”

Sinha expects that investors and managers would become more cautious, though. “In the aftermath of recent happenings, we expect institutions to revisit their large exposures and focus on building an optimally diversified portfolio,” he noted.

“We do not believe that the long-term positive outlook on private debt changes. We just expect a stronger emphasis on risk management and more oversight on lending portfolios, which are all positive for investors.”