The private credit debt markets have little direct exposure to either Russia or to the raw commodities industries. But as the conflict rumbles on, sustained impacts such as higher energy prices and food scarcity, e.g. a lack of sunflower oil, could weigh on the credit worthiness of swathes of leveraged borrowers.
The private credit market has been relatively well insulated from the crisis in Ukraine. Less than a third of the companies covered by Fidelity International analysts have any direct or indirect exposure to Russia or Ukraine. Where exposures exist, these are not typically large, and few European leveraged loan borrowers have a presence in the region beyond operational outposts. The one third of the credits covered that do have some sort of trading relationship with counterparties in Ukraine or Russia are not material: such operations typically accounting for less than 2 per cent of group revenues or purchases. Even those firms with small operations in Russia note that they have little by way of cash balances in the country.
But in a recent survey conducted by our team, borrowers report that second- and third-order effects are likely to have a much greater and more complex impact on players in the private credit market in future. Higher commodity prices, and difficulties sourcing certain products, will affect production, supply chains, and consumer confidence. Long term, these are likely to result in a dent to earnings across many sectors, particularly autos, chemicals, consumer, and related industries, damaging credit quality and potentially pushing risk higher. Affected sectors could also see a fall in issuance.
One of the more immediate effects of the political instability has been rising energy prices. And while private markets in Europe have little exposure to the oil and gas sector directly, with no primary market issuance from these industries in 2021, and only EUR€3.31 billion in total since 2010, the rising price of energy could still be a critical point of exposure for many mid-market businesses in Europe.
Credits from sectors like the services industry face little exposure to rising energy expenses on a cost basis. However, other firms that have higher energy requirements for operations and transportation, such as those in the retail and manufacturing sectors, face a less assured outlook, even where frequently renegotiated and index-linked contracts with suppliers allow the pass-through of material price changes - largely due to the lag present in such pass-through agreements.
One print services firm notes that a 10 per cent movement in the oil price since the end of 2021 would have resulted in a US$15 million cost if it had not taken any hedging action, wiping out almost half of its quarterly adjusted EBITDA.
Taking a long view, the war could accelerate a transition to sustainable energy sources that could mitigate these pricing fluctuations; in the immediate future, they will be felt on companies’ balance sheets. But in the coming months, we also believe there is a significant chance that companies with stronger ESG metrics will adapt better to the new reality, being more likely to manage probable shocks to cash flow.
Elsewhere, credits from the food and beverage industry - which made up 8.7 per cent of primary deal volumes in 2021 - note that they are already experiencing reduced supply of edible oils, in particular sunflower oil, from the region. While in the past these companies were able to pass on rising costs to the consumer, the shortages caused by the conflict may mean that adequate supplies of certain ingredients are restricted, no matter what the price and despite hedging policies in place. In these cases, companies will have to find substitutes within their recipes, in turn potentially pushing up the cost of other edible oils across the market.
Other third-order effects from the war may only become evident over a longer period. For example, the threat of cyberattacks has risen for all firms, boosting security software and online cyber defence companies. Other sectors such as telecoms and telecoms equipment - which made up 3.3 per cent and 1.8 per cent of primary market volumes in 2021 respectively - may welcome a long-term influx of cash from investors looking for a stable safe haven to house their cash.
No matter the outcome of the war, the long-term impact of the crisis on the region and on the global economy will be significant. Even for relatively shielded sectors like the private debt market, where borrowers remain optimistic about their positioning, the effects could be complex and deferred for some individual credits. The real challenge of the coming few months and years will be to identify these spots of risk within what should continue to be a broadly stable asset class and take advantage of any mispricing opportunities.
