The opportunities for private credit may be expanding even as financial markets grow more turbulent and uncertain, according to Goldman Sachs Asset Management (GSAM).

Higher quality borrowers that may otherwise have issued debt in the public markets are seeking financing in private markets, attracted by certainty and speed of completing these transactions, Stephanie Rader, GSAM Global Head of Private Credit Client Solutions, and James Gelfer, in Portfolio Solutions for Alternatives Capital Markets and Strategy, write in a report. As interest rates climb, these loans are pricing at wider spreads (relative to similar-maturity high-yield bonds or leveraged loans) and higher overall yields, and they have more conservative capital structures.

And while they expect default rates to rise in the next few years, Rader and Gelfer project private debt to outperform public credit as more borrowers struggle to repay their obligations, owing to “selective sourcing, robust diligence, enhanced structure, direct access to the borrower and financials, and the ability to influence workout situations to maximize recovery value.”

There are signs that more borrowers may have a harder time repaying loans. Distress levels for high yield bond and leveraged loan markets have risen to about 9% as of the end of March, up from about 2% in 2022, according to Pitchbook/LCD data. At the same time, many private equity-backed borrowers face rising interest expense due to the floating-rate nature of much leveraged buyout (LBO) debt.

However, distress is defined by trading levels rather than fundamentals, and there have yet to be signs of widespread operational difficulties or business deterioration, according to GSAM. Default rates are still low in high yield and leveraged loans, as well as in private credit.

Overall, while the outlook for defaults in private credit may be more opaque than in high yield or leveraged loans, the category has a number of strengths, Rader and Gelfer write. Direct lending in private credit is oriented toward financial sponsors and transaction activity. Working with PE owners enables them to better navigate economic headwinds and benefit from additional capital infusions during times of distress, extending out the time it typically takes for loans backed by LBOs to reach default. During the depths of the pandemic, borrowers and lenders worked together and private credit posted a lower default rate than leveraged loans, according to the report.