(Bloomberg) -- Private credit managers are bracing for an uptick in stress across corporate America as higher interest rates for longer mean some companies will struggle with their debt loads.

Wall Street heavyweights gathered in Beverly Hills this week for the annual Milken Institute Global Conference just days after the Federal Reserve signaled it is prepared to keep overnight lending rates elevated, if economic trends warrant.

On panels and in closed-door meetings, some expressed concern that liquidity issues for borrowers that binged on debt when rates were low are being masked by amendments to loan terms, such as maturity extensions and payment-in-kind arrangements.

A spike in such amendments last year - which has kept default rates low so far - was meant to buy time for rates to fall, a prospect that’s now looking unlikely. But the hidden strain remains as investments made from 2019 to 2022 were highly leveraged, with a view that interest rates would stay low for a long time. 

“This cannot be extended forever,” Katie Koch, chief executive officer of the TCW Group Inc, said in a Bloomberg Television interview at the conference. “Eventually those default rates will rise.”

While many borrowers are still notching revenue growth and have absorbed the higher rates, the struggles of weaker companies could provide the first real test for a global private credit market that’s grown to $1.7 trillion of assets. Much of that money was raised by managers who started after the financial crisis more than 15 years ago. 

Read more: Troubled Borrowers Seen Fighting for Runway Without Fed Cuts

An economic downturn could become a make-or-break point for some who entered private credit in recent years, according to Blue Owl Capital Inc. Co-Chief Executive Marc Lipschultz. 

“Some managers will prove that they are marginal and they will be shaken out of the system,” he said.

Rescue Loans

Yet some firms are preparing to take advantage of any jitters in the direct lending or leveraged loan markets by providing rescue-type financing for troubled borrowers to help bridge gaps in liquidity. 

Oaktree Capital Management has been reducing its exposure to broadly-syndicated loans, and shifting to collateralized loan obligations and cash in its multi-asset credit portfolios, to be ready to take advantage of market volatility. The firm is looking to provide more rescue financings to companies with liquidity needs through its private credit business.

Firms including Goldman Sachs Asset Management and Ares Management Corp. also already have dedicated funds to provide so-called hybrid capital. These financings are structured to sit between existing senior debt and common equity, and typically allow companies to pay down borrowings, and also meet at least some of their interest payments with additional debt, which frees up cash flow for operations. 

“It is going to be ugly,” said Danielle Poli, a portfolio manager at Oaktree, referring to some companies that may not be able to meet their obligations as maturities approach. “Many of these companies are burdened with excessive leverage with holes in their covenants like Swiss cheese.”

Sponsors are prepared to wait until they can earn their way back to higher valuations before exiting company investments, and are finding willing partners in private credit to help, said Jeffrey Solomon, president at TD Cowen. 

“That’s a market where you’ve got a lot of savvy people who can figure out how to restructure debt in order to allow for the equity grow,” he said on one of the panels. “Maybe they take a little bit of equity alongside it.”

M&A Rebound

A big question among attendees was on the timing of a revival in leveraged buyout and acquisition activity. The tone at the conference was cautiously optimistic as interest rates stabilize and more sellers begin to accept a long-term drop in valuations.

Things are “much better than last year,” Anu Aiyengar, global head of M&A at JPMorgan Chase & Co., said in an interview on Bloomberg Television. “The biggest difference I’d say is certainty. More realistic valuation expectation from sellers and a bit more, what do you say, courage in dealing with the regulatory environment.”

Read more: M&A Confidence Abounds From Sydney to LA: Bloomberg Deals

Leveraged loans and private credit are both open for business to fund new leveraged buyouts, said Peter Toal, head of global fixed income syndicate at Barclays Plc, in an interview at the conference. “Financing is no longer the challenge,” he said. “The markets are very open and conducive and accommodating to new leveraged buyouts.”

Deals

  • C3 Rentals, a trailer rental business, has secured a $100 million asset-based credit facility from private credit lender WhiteHawk Credit Partners
  • Guggenheim Partners is talking to lenders, including private credit firms, to gauge their interest in financing the potential $6.6 billion buyout of US department store chain Macy’s Inc. by investment firms Arkhouse Management Co. and Brigade Capital Management
  • Europe’s largest supermarket retailer Schwarz Group is set to raise about $1.8 billion through a privately-placed bond sale
  • A unit of Josh Harris’ 26North Partners LP has completed a $4.9 billion re-insurance deal that brings the firm’s total assets under management to about $22 billion
  • TA Associates and Montagu Private Equity have jointly entered exclusive talks to buy French wealth management software company Harvest entirely with equity. They later will arrange a private credit debt package
  • Barings will lend in excess of $150 million in senior secured credit facilities to Acclime HK Ltd, a corporate and advisory services firm in Asia
  • UBS Group AG is sounding out investors for an $800 million leveraged loan that will refinance debt from Royal Oak Enterprises, a charcoal maker
  • Brookfield Asset Management struck a partnership with Castlelake LP to get a majority share of the private debt firm’s fee-related earnings, another move in the Canadian investing giant’s effort to grow its credit business
  • TCW Group Inc. and PNC Financial Services Group Inc. are partnering on a private credit platform targeting middle-market companies, aiming to have $2.5 billion in its first year
  • Intermediate Capital Group closed a A$270m financing for the acquisition of Cura Day Hospitals Group last week
  • Materials company Kymera International is in conversations with lenders, including private credit firms, to refinance its debt and pay for a potential acquisition
  • Buyout firm Cinven is looking to refinance business services firm JLA after pulling a planned sale of the UK company. Cinven is negotiating with direct lenders as it pursues a roughly £650 million refinancing

Fundraising

  • Private credit fundraising could grow 6.9% annually, with assets under management settling at $2.3 trillion in 2028, in a base-case scenario, according to a PitchBook report
  • Private-credit fundraising, after years of seeing inflows mostly from insurers and pension funds, will look to individuals next
  • Oaktree Capital Management is looking to raise about $2 billion for an asset-backed lending product, according to people with knowledge of the matter, the latest firm to step into the void left by banks that are retreating from structured finance

Job Moves

  • Daniel Lim, portfolio manager who worked on private credit deals at Singapore sovereign wealth fund GIC Pte, has left the firm
  • Blackstone Inc. hired Tom Blouin, global co-head of leveraged finance at Barclays Plc, as a senior managing director
  • Blue Owl Capital Inc. has hired Johann Santer as managing director and head of APAC private wealth

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--With assistance from John Sage, Silla Brush and Jill R. Shah.

(Updates with quote from Aiyengar in 16th paragraph. An earlier version corrected the Ares company name in 11th paragraph.)

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