According to Reuters, private credit funds in Europe are increasingly relying on bank loans to enhance their performance, sparking concerns about the growing risks associated with this interconnection.
Research from MSCI Private Capital Solutions, shared with Reuters, indicates that a record 80 percent of new European private credit funds utilized bank loans, known as ‘subscription lines’, in 2023 to lend money before tapping into investor funds.
Some credit funds employ subscription lines to augment returns, particularly during their initial operations, as revealed in an MSCI study.
Regulatory bodies, including the Bank of England (BOE), are scrutinizing the risks linked to lenders’ exposure to these lightly regulated credit funds.
The emergence of shadow banks has raised alarms among certain financiers due to the potential for new asset bubbles that could destabilize financial stability. Chris Naghibi, COO of First Foundation Bank, cautions that increased bank involvement in private credit exposes them to inherent sector risks.
Several private credit funds are leveraging their loans to maximize returns, a practice that also amplifies potential losses. This trend coincides with a surge in corporate distress in Europe, reaching its highest level since the onset of the COVID-19 pandemic.
While European private credit funds manage $460 billion, smaller than bank lending, their expansion amid an economic slowdown raises concerns that private lending might defer business restructuring decisions.
As these funds are not obligated to disclose detailed loan information or their leverage levels, regulators and bank investors face challenges in assessing the deterioration of credit fund lending.
A recent BoE study indicated minimal defaults in the private credit market compared to riskier lending segments.
S&P Global forecasts a 3.75 percent default rate by June for European speculative borrowers under its monitoring.
European private credit funds employ flexible lending and intricate refinancing strategies to avert defaults, with nearly 70 percent of deals involving a single lender.
Some funds adjust loan terms to postpone stress, potentially leading to diminished recoveries, while others collaborate with company owners to mitigate losses.
The use of payment-in-kind facilities (PIKs) in lending deals doubled in the last quarter of 2023.
One-fifth of deals and banks have extended loan repayments and maturities, respectively, deferring the reckoning with higher debt costs, with banks obligated to disclose this in their reportable data.
