Rating firms cautious ratifying some private credit loans

 Banks and insurers are making more requests to U.S. credit agencies for ratings on their risky loans to private equity funds that are secured against the value of their portfolio investments and cash flows that come from them.

So far, the response from the agencies including the top 3 - S&P, Moody's and Fitch - has been cautious because the valuation of the assets backing the loans are difficult to assess as they are owned by an opaque investor base.

A higher-for-longer interest rate environment over the last few years has limited opportunities for private equity fund managers to profitably exit investments in their portfolios.

They are instead starting to rely on loans to reinvest in existing portfolio companies, wait for a better time to exit these investments, make new acquisitions or pay dividends to their investors in the funds.

This activity has raised concerns about so-called leverage on leverage in private credit, a growing area of private fund finance.

Lenders are now approaching rating agencies to get credit ratings on their loans in a bid to lower the amount of capital needed on these loans and as an added due-diligence of the risk, senior rating officials said.

Agencies are balancing this fee-generating potential with a methodical approach.

Only two - S&P Global Ratings and KBRA - of the four agencies interviewed by Reuters rate net-asset value or NAV loans which are riskier because they are secured based on the theoretical valuation of an almost fully invested fund.

Valuations are much harder to assess in an environment where default rates in the invested portfolio companies are expected to rise as they struggle with higher interest expenses.

These loans have a shorter history in comparison to other types as their demand and wider use rose only in the last few years as exits through asset sales became harder in a higher-for-longer rate environment.

Their volumes are growing.

"We expect the approximately $150 billion in NAV facilities that some market participants have currently seen in the market to double within the next two years," S&P said in a recent report.

But only one of the top 3 rating agencies even has a methodology to rate them.

Moody’s Ratings does not have one for NAV loans, said its associate managing director, Rory Callagy.

"NAV loans are newer and there is less standardization of lending terms in this market," said Callagy.

"The collateral backing NAV loans are private investments whose values can be hard to assess because there is less transparency on the valuation of the assets," he added.

https://finance.yahoo.com/news/rating-firms-cautious-ratifying-private-101145008.html