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Firms flocking to commit to private debt lack confidence in handling a further downturn

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Capital market investors are flocking to and expanding their private debt strategies, despite almost half lacking confidence in their ability to handle defaults in a post-pandemic downturn, new research shows.

Almost nine in ten capital market investors are pursuing direct lending strategies according to a survey by Ocorian, with the majority (57%) expanding an existing strategy and 30% having a strategy that they are in the process of executing.

But Ocorian said the study highlighted a shortage of confidence among investors that their direct lending abilities will be sufficient to weather any upcoming storm.

They expressed the least confidence in addressing loss recoveries (47%), risk assessment (53%), statement production (54%) and covenant monitoring (57%), the report said.

Respondents from firms less than 10 years old were least sure of their loss recovery capabilities when it came to direct lending, with only 41% expressing confidence.

Regionally, confidence levels in having robust loss recovery capabilities were lowest among European respondents (28%) – significantly behind North American (40%), African (48%) and Asian (72%) respondents.

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

Alan Booth, global head of capital markets at Ocorian, said, “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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