2024 | Private credit outlook: A question of balance For professional clients only.
Capital at risk.
2024 private
credit outlook:
A question of
balance
Lushan Sun
Private Credit Research Manager
LGIM Real Assets
Executive summary:
• Despite the resilience that characterised 2023, we believe
the lagged effects of monetary tightening in US and Europe
will mean that the transition to a new equilibrium is unlikely
to be seamless. We now expect several rate cuts in 2024,
but given high inflation and a strong labour market, the path
ahead is not straightforward.
• While debt yields are still high in a historic context, public
credit spreads have tightened materially over recent weeks,
especially in high yield. We believe investors should keep a
strategic eye on structural trends balanced with a tactical
eye on credit quality and risk-adjusted returns. Our cautious
outlook means that we like resilient business models and/
or conservative leverage that should allow borrowers
to cope in an economic downturn.
• This pushes us to focus on the investment grade and
crossover segments of the private credit markets, where
we think the risk-adjusted returns are attractive.
Asset selection and maintaining strong covenants
are more important than ever. We still like duration, but note
the window of opportunity may be closing.
• A reduction in bank lending in 2023 has encouraged more
corporate borrowers into private markets and created some
opportunities in alternative debt. We expect this trend
to continue.
• We expect existing real estate debt assets to face
sustained pressure in 2024, but the current environment
is potentially creating an opportunity to provide debt
funding on attractive terms, provided asset profiles and
business plans support long-term performance.
2024 | Private credit outlook: A question of balance
Our key considerations for 2024
1 Soft landing, disinflation, rate cuts: all at once? • Despite growing positivity, we think it will remain a
challenge to balance sustained GDP growth, falling inflation
• The economy has been resilient in the face of a historic and rate cuts. It may not take many surprises to knock the
hiking cycle. Consumer savings, low debt costs and fiscal economy off course, and as such we remain cautious.
stimulus have helped the economy live with higher rates,
but their effects have diminished over time and may now • Credit spreads have been remarkably stable. Negative
be beginning to reveal the transmission effect of higher economic news may create a window for a widening of
interest rates to the broader economy. spreads that could offset any reduction in rates.
• Softening inflation and the strength of the economy led to
the US Federal Reserve (Fed) declaring in November 2023
that rates have peaked and are likely to come down in 2024.
This drove a significant market rally in the final two months
of the year.
Higher debt costs have yet to be felt by the majority of corporates
10
9
8
7
6
Debt coupon
5
4
3
2
1
0
9
13
15
17
19
21
23
7
1
0
20
20
20
20
20
20
20
20
20
IG coupon HY coupon Loans coupon
Source: Bloomberg, JP Morgan as at October 2023
The value of any investment and any income taken from it is not guaranteed and can go down as well as up, and investors may
get back less than the amount originally invested.
2
2024 | Private credit outlook: A question of balance
3 Watch out for megatrends
• We have more conviction in highly rated private credit (i.e.
IG and BB), where in our view the risk-adjusted returns on
offer are compelling. Leverage is generally more
conservative, the borrower base is becoming more
diversified, and this part of the market has come through
several economic cycles with minimal defaults.
• We think the recent steepening of the yield curve has made
duration more attractive. The availability of fixed-rate debt
2 Balancing yield, risk and duration in the highly rated space means there is a potential
opportunity to lock in higher returns for a longer period.
• The flip side of higher rates is attractive debt yield. Public The challenge is the current scarcity of long-dated
credit yields are currently around the 70-80th percentile issuance, as borrowers avoid locking in higher debt costs
versus their 20-year history. Investment grade (IG) private for longer.
credit is currently yielding at around 5-8%, and sub-IG
private credit around 9-13%.1
• However, we need to balance the returns on offer with
potential risk, and given our cautious outlook, we are still
wary of aggressively chasing returns. We think sub-IG
private credit issuers could come under increasing
pressure from weaker revenue growth and elevated funding
costs.
• Some borrowers over-levered when rates were near zero
and are now facing unsustainable capital structures. In our
view a rise in defaults, restructuring and write-downs is
likely, although we don’t expect a GFC-style crisis. We think
newer vintages (2022 and 2023) are likely to perform better,
benefitting from lower leverage and asset valuations.
European bond issuer interest coverage by rating
12
10
8
Interest coverage
6
4
2
0
15
19
23
3
2
1
20
20
20
20
20
20
20
20
20
20
20
BBB BB B
Source: Bloomberg as at November 2023
1. Source: LGIM as at January 2024
The value of any investment and any income taken from it is not guaranteed and can go down as well as up, and investors may
get back less than the amount originally invested.
3
2024 | Private credit outlook: A question of balance
Corporate debt Real estate debt
The corporate debt market enjoyed a busy 2023, helped by Real estate debt faced many challenges in 2023: higher
borrowers looking to diversify their funding sources after the interest rates, property re-pricing and the regional banking
banking crisis in March. Borrowers appear to have realised that crisis. Together, these drove a significant flight to safety by
debt costs are unlikely to fall soon, so decided to get on with lenders. The availability of finance has held up in residential,
their refinance and investment plans – but generally focusing logistics and certain alternative sectors. Retail and offices are
on shorter maturities (15 years or less). For example, we saw struggling (except for very high-quality assets), as are
minimal activity from UK housing associations for the first properties with poor sustainability credentials. Lender appetite
three quarters of the year, followed by several transactions is trending lower, demonstrated by smaller average loan sizes
during Q4. in the UK over the first half of 2023.
The European market saw a notable broadening of corporate Lenders have so far been supportive, with sponsors injecting
sectors, including several sought-after names from the capital in many cases. However, there are signs that, with the
industrial, services, and food and beverage sectors. We see market not yet recovered, some lenders would like to reach a
this as positive for investors looking to add defensiveness to resolution soon. 2024 also marks the point when loans taken
their portfolio. The US market has been less diversified and out in 2019 – the valuation peak for most sectors – will reach
has been dominated by utilities and infrastructure – sectors the end of the typical five-year maturity. Refinancing these
better able to pass on the higher debt costs to the consumer. loans could be more challenging than earlier vintages due to
lower equity buffers. We may see more lenders enforcing or
A busy pipeline led to a bifurcation in investor demand. encouraging sales in 2024 which could accelerate price
High-quality borrowers were regularly oversubscribed, but discovery and help the market bottom out.
weaker borrowers needed to offer additional incentives to get
traction, for example longer maturities, higher premia, or Despite the challenging backdrop, our opinion is that the
additional ESG KPIs. current environment offers potential opportunities for investors
to provide financing on attractive terms. Yields are high,
We expect 2024 to be another busy year as tight bank lending loan-to-value is lower (to support interest coverage), and
conditions are expected to remain in place for a while. This there is less bank competition. That said, macroeconomic
could generate potential opportunities for private credit uncertainties demand a careful assessment of cashflow
investors, and we think issuer diversification should improve in risk and ESG-related capex needs.
the US once the Fed starts cutting rates. We favour counter-
cyclical sectors with strong cash flow generation. Maturities We favour sectors supported by demand-supply mismatch
are likely to remain short, which is less desirable for liability- and long-term structural trends, such as residential, student
driven investors that need duration. accommodation, industrials and data centres.
Refinancing wall over the next five years
600 100
90
500 80
400 70
60
US $m
300 50
£m
40
200 30
100 20
10
0 0
23
24
25
26
27
20
20
20
20
20
UK (RHS) US (LHS)
Source: MSCI, Bayes Business School, December 2023
The value of any investment and any income taken from it is not guaranteed and can go down as well as up, and investors may
get back less than the amount originally invested.
4
2024 | Private credit outlook: A question of balance
Infrastructure debt Alternative debt
Relative to other sectors, infrastructure debt activity was more Alternative debt saw another year of strong pipeline and richly
subdued for much of 2023. Infrastructure equity pricing has priced opportunities. Retrenchment by the banking sector and
been slow to adjust to the higher rate environment which the upswing in funding costs encouraged borrowers to shift
makes the economics of project financing more difficult. towards the institutional market. A growing imbalance between
Transactions generally focused on corporate refinancing deals, supply and demand has emerged, pushing spreads c.100-
particularly in Europe. 150bps wider over the year, with transactions focused on
short-dated opportunities. Long-dated swap repacks have
Lower pipeline volume means that investor demand remained been less active, with rising rates improving the mark-to-
strong, with some deals over-subscribed by multiple times. market value of the swaps on the banks’ balance sheet.
The transportation, energy, and digital sectors dominated
issuance. P3-related activity in the US and Canada has Demand for fund finance solutions from private market general
increased, with recent deals including toll roads, education, partners (GPs) has been strong, but it is important to take the
healthcare and rail. broader context into account – among other issues, the M&A
environment remains subdued, fundraising remains weak, and
We expect infrastructure debt to perform well in 2024, with valuation re-pricing is lagging. We advocate a cautious and
high pricing power offering potential downside protection in selective approach to assessing GP credit risk, avoiding
a recessionary environment. Activity increased in the last four exposure to higher-risk sectors and diversifying into other
months of 2023, as sponsors learnt to live with a high-for- asset classes like private credit and infrastructure.
longer environment, and we expect it to recover further once
the prospect of rate cuts becomes more evident. Debt-for-nature swaps proliferated in 2023, with the $1.6bn
Ecuador deal the biggest. This is an area where we expect
Pricing has become in our view more attractive, but tighter strong growth in the coming years.2 While debt-for-nature
overall than other private credit asset classes as asset swaps alone are no panacea, we expect them to play an
fundamentals remained resilient. We are seeing relatively increasingly important role in helping to support developing
higher premia in crossover-rated assets, where competition economies and potentially providing investors with ESG-
is less given limited bank participation. aligned high credit quality opportunities.
2. Source: www.iadb.org/en/news/ecuador-completes-worlds-largest-debt-nature-conversion-idb-and-dfc-support
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2024 | Private credit outlook: A question of balance
Where next for investors?
2023 was a good year for private credit, driven by high yields, Despite increased investor optimism around a soft landing,
economic strength and borrowers’ desire to reduce reliance on we believe there are still too many uncertainties and prefer
bank lending. At the time of writing, the key uncertainty is the a more risk-focused approach. We view the risk-adjusted
timing and depth of a recession. returns in investment grade and crossover private credit as
attractive, and so is duration. In terms of sector exposures,
This is a double-edged sword. Stronger growth is supportive we lean towards needs-based assets, borrowers with resilient
of fundamentals, but is likely to keep rates higher for longer, business models and/or long-term structural shifts, which
so not helpful for refinancing. A deep recession would reduce we believe are better able to cope with recession or a higher
the cost of debt but would damage consumer demand and rates environment.
broader market stability. Geopolitical tensions add further
complications to the mix, as does AI. We believe this
represents an enormous opportunity in some sectors,
while other borrowers risk being left behind if they are either
disrupted by the technology, or fail to leverage it to its full
potential.
Despite increased
investor optimism
around a soft landing,
we believe there are still
too many uncertainties to
ramp up risk at this stage.
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2024 | Private credit outlook: A question of balance
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amount you originally invested.
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