We believe private credit appears poised to outperform in 2023 as public markets struggle to find direction and the macro picture points to economic contraction.
The current environment particularly favours private credit lenders for several key reasons:
1. Higher yields: All else being equal, higher base rates are advantageous for lenders as both fixed and floating rate loans price with higher coupons. This is the case of a rising tide lifting all boats. Of course, there are two sides to every loan; higher expected income accruing to the lender is only as good as the borrower’s ability to pay. There becomes a tipping point where default losses will overcome yield. In this environment, a strategy focused on conservative underwriting, to strong counterparties, at appropriate terms, is more likely to deliver strong performance.
2. Robust demand: Business owners plan strategically: 5-year plans, 10-year plans and even longer time horizons. We see a strong pipeline forming with proceeds used both to finance M&A and consolidate competitive positions, and to fund CapEx as owners position for long-term growth. Further, the generational transfer of wealth has created significant opportunities to support management buy-outs.
In addition, the IPO market remains largely shuttered, increasing the holding period for private equity sponsors. This creates significant demand for refinancing and the opportunity for lenders to term-out higher coupon debt.