Higher interest rates have increased the return on private credit investments, and credit opportunities have increased as banks and other traditional lenders have reduced their lending activities. This was evident in the U.S. following the collapse of Silicon Valley Bank in March, and Lawrence said a similar trend was seen in Canada, with banks reducing their exposure and focusing on higher-margin customers.
If the economy continues to deteriorate in 2024, credit conditions could tighten further, he said.
But while an economic downturn creates opportunities for personal loans, the risks also increase.
A report from DBRS Morningstar on Tuesday warned that the “golden age” of personal loans may be coming to an end. The ratings agency's 2024 outlook for business development companies predicted that the positive environment that has boosted retail lending this year may not last.
“We expect business development companies will find it difficult to maintain peak profits in 2023 into 2024 as policy rates level off or decline and credit spreads tighten to normalized levels due to competition,” said Watson Tanlamai, vice president of the Global Financial Institutions Group at DBRS Morningstar, in a press release.
A report from S&P Global this month also said growth in personal loans faces challenges in the coming year. While opportunities in the sector remain “robust” even after a breakout in 2023, S&P warned of rising default rates.
“Financial risks weigh more heavily on credit quality for borrowers with weak business risk profiles or high leverage,” the report said. “In particular, companies that issue floating rate debt, such as from private lenders, will be vulnerable to higher financing costs if interest rates are higher over the longer term.”
Therefore, the rating agency expects the trailing 12-month default rate of speculative grade companies to reach 5% in the US by September 2024 (vs. 4.1% in September 2023) and 3.75% in Europe (vs. 3. 1 %).
For investors, examining the approach of private credit fund managers will become more important next year, Lawrence said.
“When there is a certain level of stress in the environment, private lenders must have the necessary skills to properly underwrite and stress test a borrower's loan and structure loans that provide the right protection and risk mitigation in order to to avoid negative consequences,” he wrote.
Still, he said there is potential for solid returns in private credit next year as yields remain attractive and the asset class sees growing demand from institutional and retail investors seeking diversification.
Private equity, on the other hand, has struggled amid higher interest rates and would benefit from monetary easing. Transaction activity has fallen sharply over the past two years as most transactions use leverage and valuations have been impacted.
“The correction in public markets is beginning to be reflected in moderately lower private equity valuations,” says BlackRock’s private markets outlook in 2024. “After rising steadily since the global financial crisis, valuations are in 2023 sunk.”
With fewer exit options, limited partners are turning to the secondary market to obtain liquidity and meet distribution needs, the report said, creating buying opportunities. BlackRock said it expects deal activity to increase in 2024.
Lawrence said an economic slowdown could lead to greater downward pressure on portfolio valuations and serve as a “catalyst for a new buying cycle later in the year.” In most cases, downturns present opportunities for those with dry money (i.e. cash) to deploy,” he wrote.
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