Blue Owl: Private Credit Sturdy, Eyes 15% Income Rise in 2024

Key Takeaway

• Blue Owl Capital's Marc Lipschultz emphasizes private credit's resilience despite market uncertainties, advising careful manager selection.
• Deutsche Bank analysts predict rising corporate default rates due to higher interest rates, ending a long era of low defaults.
• Investment-grade credit demand is strong, driven by increased interest income and limited supply, with BofA projecting a 15% rise in total income for 2024.

Private Credit Market Uncertainties

The private credit market, valued at $1.7 trillion, is currently facing uncertainties, as highlighted by recent events and industry insights. Marc Lipschultz, co-founder and co-chief executive officer of Blue Owl Capital Inc., emphasized that private credit remains a viable investment despite some industry warnings of potential weaknesses. Lipschultz noted, "I haven’t seen an up-tick in defaults or companies having performance troubles yet," but acknowledged the market's evolving uncertainties.

A notable incident that has raised concerns involved Vista Equity Partners-backed Pluralsight Inc., which shifted assets away from its direct lenders. This move has spurred worries that it might not be an isolated case. Additionally, direct lenders have been pitching deals with structures designed to circumvent bank lending constraints. Lipschultz advised investors to "pick their manager wisely, understand their strategy," and to be vigilant about the manager and structure if they wish to retrieve their capital.

In a related development, investors in Canadian investment manager Ninepoint Partners LP faced difficulties in accessing their funds when the firm temporarily suspended cash distributions in three of its private credit funds to preserve cash. This incident underscores the importance of careful manager selection and understanding the underlying investment structures.

Rising Default Rates

Analysts at Deutsche Bank AG have indicated that the era of low corporate default rates, which has persisted for the past two decades, is coming to an end. The increase in interest rates is expected to lead to a higher number of borrowers failing to repay their debts. Deutsche Bank analysts, including Jim Reid and Steve Caprio, stated, "For 40 years, virtually all fixed-rate borrowers across the economy could refi at a lower rate than they’d previously achieved. This changed after 2022, but the full impact could still be slow to be felt."

The analysts pointed out that central bankers' efforts to combat rising prices by increasing rates have made borrowing more expensive for riskier companies, leading to an uptick in defaults globally. While defaults have not yet reached the anticipated levels, the analysts believe that a structurally higher level of defaults is likely in the coming years. They also highlighted the potential impact of the maturity wall, with more than 20% of sub-BB borrowers facing maturities in the next three years.

Investment-Grade Credit Demand

Despite the challenges in the private credit market, corporate bond investors are experiencing increased interest income due to rising rates since 2022. According to strategists at Bank of America Corp. (BofA), the total income generated by the corporate bond market is expected to be about 15% higher in 2024 compared to the previous year. This increase in interest income is driving demand for investment-grade credit, even as issuance volume is projected to decline in the second half of the year.

BofA strategists, including Yuri Seliger, noted that from June to December, total coupon payments are expected to amount to approximately $220 billion, while net supply is likely to be around $89 billion. This imbalance between rising demand and limited supply is expected to keep investment-grade technicals strong for the remainder of 2024. The main index monitored by the strategists stood at a spread of about 92 basis points on Friday, with expectations for it to remain between 90 and 110 basis points over the next six months.

Additionally, investment-grade bond sales volume tied to acquisitions has been declining. In May, there was about $12.6 billion of merger and acquisition-related issuance, down from $54.9 billion in February, according to BofA strategists.

Street Views

• Marc Lipschultz, Blue Owl Capital (Cautiously Optimistic on private credit market):

  "Private credit is still a good place to invest... Investors need to pick their manager wisely, understand their strategy. And if an investor wants their capital back they should, pay attention to the manager, pay attention to the structure."