Strong demand factors underpin private credit

Did the Russian invasion of Ukraine exacerbate some of the inflationary pressures that were already happening?

TYLER LINDBLAD: Yes, inflation was already a problem before the Russian invasion of Ukraine. It’s certainly something we’ve been focusing on since last October, long before the [Federal Reserve] acknowledging that inflation was, in fact, not transitory and was more of a problem. Given how we perceive the geopolitical situation and its wider impacts on commodities and the food chain, [the invasion] will exacerbate this inflationary pressure.

As a private credit manager, we continuously perform granular analysis of our portfolio companies as macroeconomic conditions evolve. In this case, we determined the level of direct exposure if they do business in Russia, as well as indirect exposure in their use of raw materials and other supply chain issues. We also conducted a similar granular analysis of companies in their exposure to inflationary pressures. We define it as high risk if they experience increased costs that may impact margins in the long term, medium risk if the impacts are temporary, and low risk if there is no impact. .

Also, what I would highlight as good news [as we assess the inflation picture] is that consumer demand remains very strong. The US economy continues to grow, and although there is a risk of a slight decline in margins [by companies]that’s going to be absorbed by equity, and that doesn’t pose, from our perspective, any real risk from a debt or principal risk perspective.

What are some of the key metrics you’re watching as we look to the future?

LINDBLAD: As interest rates rise and the Fed is obviously more hawkish, you start to see that demand could potentially slow. We currently believe that the US economy is still well positioned in 2022 and into 2023. But clearly the risk of some sort of recession or stagflation has increased. The Fed has a new tightrope to walk on, and [the risk] going to make their efforts a little more difficult. This is certainly something we also pay attention to.

When rates rise, private credit is variable rate, which provides the benefit of increased interest income. How do you feel about this as it relates to your borrowers?

LINDBLAD: Interest rates by historical standards are still very, very low. Even after the projected increases we see coming, you are still looking at LIBOR [London Interbank Offered Rate] or SOFR [Secured Overnight Financial Rate], [which are] potentially in a range of 2.5% to 3%, which remains very attractive by historical standards.