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Private debt investors doubt their ability to handle defaults in a post-pandemic downturn, says new research

An overwhelming majority (87 per cent) of capital markets investors are pursuing direct lending strategies though almost half (47 per cent) lack confidence in their ability to manage loss recoveries which could have serious implications if corporate defaults rise as pandemic-driven government support schemes are withdrawn.

According to a Capital Markets report, called Navigating CovExit: searching for value in the debt markets, commissioned by fund administration and corporate and fiduciary services provider Ocorian, the majority (57 per cent) of capital market investors have an existing direct lending strategy which they are looking to expand and 30 per cent have a strategy that they are in the process of executing. 

With USD207 billion having been deployed by 327 direct lending funds globally over the past 10 years, the study highlights a shortage of confidence among investors that their direct lending abilities will be sufficient to weather the storm. They expressed the least confidence in addressing loss recoveries (47 per cent), risk assessment (53 per cent), statement production (54 per cent) and covenant monitoring (57 per cent).

Ocorian commissioned independent research among 100 capital markets decision makers working in investment banks and private capital firms in Europe, North America, Africa and Asia to assess their operational readiness as they plan their post-Coronavirus pandemic investment strategies.

Respondents from younger firms less than 10 years old were least sure of their loss recovery capabilities when it came to direct lending, with only 41 per cent expressing confidence. Regionally, confidence levels in having robust loss recovery capabilities were lowest among European respondents (28 per cent) – significantly behind North American (40 per cent), African (48 per cent) and Asian (72 per cent) respondents. 

Despite their concerns, some 92 per cent of respondents expect corporate insolvencies and restructurings to present opportunities to them over the next 12 months, including 22 per cent who believe these opportunities will be significant.

Alan Booth, Global Head of Capital Markets at Ocorian, says: “Relatively few defaults to date suggests that private debt investments have been resilient, but government support and the low cost of funding may be masking a varying degree of trauma in the market. As this support is wound down and interest rates rise we can expect to see distress and indeed opportunities in certain sectors. How private debt managers react will be varied and we are likely to see the hawks outnumber the doves. 

“Despite their operational concerns and a weakening in the short-term fundamentals in private credit markets, investors are increasingly drawn to the sector in anticipation of debt restructurings as well as M&A activity arising from the pandemic. However, funds pivoting from private equity or real estate towards direct lending may have challenges in adapting their infrastructure to meet their need for quick execution. 

“It’s vital managers have sufficiently robust and scalable operational, risk and compliance processes in place either in-house or through an outsourced arrangement to avoid delays and unnecessary risk to themselves and their LPs.”

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