Middle market borrowers seeing an increase in default rates, according to Morningstar's report.
In a recent report, global investment research firm Morningstar has revealed that default rates among middle-market issuers in the private credit market have doubled over the past 18 months, reaching the highest levels since Morningstar began tracking in 2019. This increase is attributed to slower earnings growth and persistent high borrowing costs impacting borrowers' cash flow.
The report further predicts further deterioration in credit quality and additional default rate increases over the next 6 to 12 months, as downgrade actions now outpace upgrades among rated issuers. Despite these concerns, Morningstar notes that the private credit market still holds significant growth potential.
The private credit market has tripled in size over the past decade, exceeding $1.8 trillion globally. The market's structural growth drivers and expanding borrower base, particularly among middle-market companies, support this outlook.
Institutional investors continue to be attracted to private credit, particularly direct lending, for portfolio diversification, low correlation to public markets, and high risk-adjusted returns. Institutional flows to private debt funds remain solid, having reached or exceeded $200bn in each of the last five years.
However, the 'retailisation' of evergreen funds raises concerns in the private credit market. Despite this, Morningstar expects well-established fund managers to continue to consolidate market share, with the top 10 raising nearly one third of total capital in 2024.
Private credit AUM is primarily composed of direct lending, and the absence of marked-to-market pricing in private credit raises some concerns but is expected to persist due to its complexity. Default activity among rated middle-market issuers has accelerated year to date, and Morningstar's rated middle-market issuers have seen an increase in defaults in the first half of the year.
Despite the rise in defaults, Morningstar predicts further deterioration in overall credit quality among middle-market issuers over the next year. However, the private credit market is still expected to grow, with the global private credit market expected to continue its expansion due to its lower assets under management compared to private equity.
In summary, the current trend shows rising defaults among middle-market private credit issuers with expectations of continued credit quality decline in the near future, though the overall market remains poised for substantial growth according to Morningstar's latest insights.
- Despite the increasing defaults among middle-market issuers in the private credit market, Morningstar still anticipates significant growth potential for this sector, particularly because institutional investors continue to pour money into private credit funds.
- With the private credit market predicted to grow further due to its lower assets under management compared to private equity, investors may find opportunities for business expansion and investing within this market, even as they consider the challenging financing environment and potential risks associated with higher defaults.
