Private Credit and Higher Rates: Opportunities and Costs

Inflation, higher interest rates and, most recently, war have roiled financial markets during the first quarter of 2022. Consumer and investor confidence is tumbling, and public markets are feeling the pressure – IPO’s, which had boomed in 2021, have ground to a halt with reports of the usually hectic schedule of City bankers seeing an increase in mid-afternoon pub visits. Public debt raising hasn’t fared any better – in Europe we have seen the longest drought in high yield bond sales in over a decade. With this critical source of funding drying up, others have had to fill the gap but as with any financial volatility, opportunities abound.

Following the GFC in 2008 banks pulled back from much of their traditional lending markets and the space was quickly filled by private credit funds. The private credit asset class is currently worth an estimated $1.3trn and some are expecting this to double over the next five years – a slowing public market will only expediate this growth. Additionally, the floating rate returns (most private lending is on a floating rate basis) can deliver investors with greater protection on returns in a rising interest rate environment than their equity equivalents – another potential growth story for private credit in the coming months.

But higher rates and increased volatility in financial markets also introduce more risk – over the past decade interest rate markets have been unusually benign, and it was during this period that private credit took off. Rates markets are now pricing in a faster hiking cycle than almost any market participant will have seen – with 2.5% of tightening expected from the Fed in 2022, a further 1.5% from the BoE, and 0.70% from the ECB – the first time the ECB deposit rate will have increased in over 10 years.