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Written by Naomi Rovnick and Sinead Crews
LONDON (Reuters) – Europe’s private credit funds are borrowing more from banks to boost their performance, raising concerns about the broader risks posed by this interconnectedness.
A record 80% of new private credit funds in Europe borrowed from banks through “subscription lines” in 2023, according to research by MSCI Private Capital Solutions shared with Reuters. This is a financing that allows for loans before taking cash from investors.
A separate MSCI study found that subscription lines are used by some credit funds to boost revenue. MSCI looked at recently established pools as funds are most likely to use subscription lines at launch.
Regulators, including the Bank of England (BoE), are already investigating the potential risks posed by lenders’ exposure to credit funds. Credit funds are loosely regulated and typically lend to companies that have difficulty borrowing directly from banks or the bond market.
The boom in so-called shadow banks has also raised concerns among some financial institutions, who are pointing to the possibility of new asset bubbles that could undermine financial stability.
“Increasing our involvement in the private credit space brings (banks) closer to the risks inherent in this sector,” said Chris Naguibi, chief operating officer at First Foundation Bank.
Some private credit funds also add leverage to loans to maximize returns, but also magnify potential losses, more than 20 industry sources told Reuters, and some This was also revealed in documents submitted to the fund.
The moves come as European business distress reaches its highest level since the start of the coronavirus pandemic.
flexibility
UBS estimates that private credit funds in Europe currently manage $460 billion, although they are a fraction of the size of bank loans. That growth has coincided with an economic slowdown, raising concerns that private lending could delay restructuring decisions.
Because these funds are not obligated to publicly disclose detailed information about their loans and the bank leverage they deploy, beyond notifying their own investors, it is important for regulators and bank investors to know whether credit fund loans are deteriorating or not. It’s difficult to know.
Recent research from the Bank of England (BoE) shows that private credit market participants have so far experienced minimal defaults compared to the broader market for lending to riskier borrowers. It is reported that there are.
Rating agency S&P Global expects the default rate among European speculative borrowers it covers to reach 3.75% by June.
“Everyone is asking why we haven’t started seriously restructuring companies now,” said Peter Marshall, co-head of European restructuring at investment bank Houlihan Lokey.
More than a dozen people familiar with the matter told Reuters that private credit funds have been able to avoid some defaults with flexible lending and sometimes complex refinancing structures.
Deloitte estimates that nearly 7 in 10 private debt transactions in Europe involve just one lender. This means that Deloitte has exclusive control over the terms offered and the interest rates charged.
Patrick Marshall, head of private markets fixed income at Federated Hermes, said some funds are changing loan terms, such as contractual headroom, to drive stress into the “long grass.” It is said that there is.
“But what’s going to happen is that (loan) recovery rates will also go down,” he said.
Chris Johnston, managing director at Alvarez & Marsal, said some funds are working with company owners to avoid crystallizing losses.
Payment-in-kind schemes (PIKs), which allow companies to accumulate interest paid in later years, were found in 3.5% of 167 direct financing transactions in six European countries in the fourth quarter of 2023, research by credit information provider Reorg found. It turned out that.
This was almost double the 1.9% of PIK-related transactions in the first quarter of last year, Reorg said.
Separately, one in five European private credit transactions in the final quarter of 2023 were debt refinancings that extended loan repayments, the highest proportion since 2020, Deloitte revealed.
“This helps us avoid the day we expect debt costs to rise,” said Andrew Wilkinson, senior restructuring partner at law firm Weil Gotshall.
Banks may also extend maturities, but must reflect this across their reportable data, such as loan quality and estimated credit loss metrics, and must make provision for this.
infectious disease
Hermès Federal’s Marshall said investors in the United States and Asia also sometimes ask European funds for additional leverage, but it is already a common practice in the United States.
Ares Management Corporation announced last month that its Ares Capital Europe VI fund had raised €11 billion in equity, giving it more than €16 billion of investable capital, including expected leverage.
Access to leverage does not necessarily mean leverage will be introduced, but these structures can loosen quickly in times of market stress, the people said.
Keith Crouch, executive director of MSCI’s private capital unit, said: “There could be some type of epidemic where funds are unable to renew their short-term debt and have to withdraw capital from investors.” There is,” he said.
Federated Hermes’ Marshall said private funds were now “part of the banking ecosystem,” adding that more regulation was “not a bad thing.”
(Reporting by Naomi Rovnick and Sinead Cruz; Editing by Elisa Martinuzzi and Alexander Smith)
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