After two years of what was deemed the “golden age” for private credit, there is going to be a significant increase in return dispersion amongst managers, according to Reji Vettasseri, lead portfolio manager at Decalia.
Speaking on a panel at SuperReturn Private Credit Europe, Vettasseri said that although most large direct lending managers will say that they have not had any problems in their portfolios, much of the issues are being handled behind the scenes.
“You’ll ask some more difficult questions and you’ll realise that they’ve had no problems on 12 times levered deals, which have been extended three times and really have no path to liquidity around them,” he said. “And you’re finally going to see the truth catch up with some of those people.”
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He added that while some managers genuinely don’t have many problems, there are those who have more than they let on.
Goldman Sachs Asset Management’s (GSAM’s) global co-head of direct lending James Reynolds agrees that for the first time in a decade, there will be real differentiation in returns.
“The shock came from the rates in 2022 going from zero to five per cent and it’s really shaking up the whole private equity industry, but also the private credit industry,” he noted.
“Effectively this is the first time that the industry is getting tested. Let’s face it, most of the players today started their lives post-financial crisis. And for the first dozen years it was a fairly benign environment.”
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He pointed out that since 2018 there have been around 120 situations in Europe where the direct lender has taken the keys of an asset, 60 of which have been in the last two years.
He said that there are also plenty of loans that have been extended, resulting in what are effectively “zombie capital structures” where the lender will eventually take over.
“Two-thirds of the sectors [among those] will be the ones that you would agree direct lenders shouldn’t have lent to in the beginning. So it’s a lot of consumer, it’s a lot of retail, it’s a lot of cyclicals, industrials. And they are pre-2019 buyouts,” he added.
“I think people are going to find it more difficult to fundraise in the future. You’re going to see consolidation in the industry, whether it’s through organic or inorganic ways. But effectively the money is going to flow towards fewer and fewer players.”
For Reynolds, one of the big determinants of performance will be the ability to originate good deals. He believes GSAM has a particular advantage because of its relationship with Goldman Sachs, the bank.
“I would say eventually on the direct lending side, the largest platforms can cover 30, 50 private equity firms, but no private credit platform can cover 10,000 plus corporates,” he said. “You have to be a bank effectively with thousands of bankers to have the relationship with the CEOs and the CFOs and have the trust of these management teams.”
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For Tamsin Coleman, a senior member of Mercer’s European private debt team, just the number of liability management exercises that took place last year and the levels of payment-in-kind loans in some portfolios shows that “things are bubbling under the surface”.
“I’d say there is actually quite a big dispersion in the amount of interest being PIK’ed, and that’s not to say that it isn’t a sensible tool sometimes as it can buy companies time to figure things out. But I think where that’s showing up essentially is to sort of ‘PIK the can down the road’, and that’s where you really should have concerns,” she said.
“It really puts a renewed focus on manager selection.”
