There are “accidents waiting to happen” in private credit because of looser lending standards and the vast amount of capital that has flooded into the sector, the chief investment officer of one of the world’s largest charitable foundations has warned.
The £37.6bn Wellcome Trust’s Nick Moakes told the Financial Times that big investors in such funds could suffer “very substantial” losses if the US economy eventually fell into recession.
“If the world gets a little bit more difficult economically, I think that there are some accidents waiting to happen in the private credit world,” said Moakes in an interview.
“If there is an issue within that whole ecosystem, there will be some quite high-profile investors, many of whom do have some kind of systemic importance, that will be quite badly damaged,” he added.
His comments come as rating agency KBRA warned yesterday that private credit borrowers struggling to pay off their debts might finally “face the music” this year as a result of higher than expected interest rates weighing down on corporate balance sheets.
The firm, which analyses large swaths of the private credit market, said that, while most loans would be paid off without a problem, borrowers whose “business models or capital structures have not adjusted to a higher rate environment” could begin to default on their debt.
As traditional banks have retreated from lending following the 2008 financial crisis, private credit, which funds a wide range of areas such as corporate acquisitions and consumer loans, has grown rapidly.
However, a growing chorus of central bankers, policymakers and some of Wall Street’s own top brass — including JPMorgan Chase chief executive Jamie Dimon — have flagged potential problems.
Moakes said that, although private credit is “less dangerous” systemically than bank financing because leverage levels are lower, private equity managers have been able to borrow large amounts of money with minimal checks and balances.
“As [the private credit market has] become popular, it has sucked in an enormous amount of capital. That has meant that the lending standards that are applied in certain parts of private credit markets have diminished,” he added.
“It’s great for private equity borrowers,” he said. But for investors, “if you see a slower economy, particularly if you end up with a recession in the US eventually, which one day we will . . . there’ll be some haircuts [losses] to be taken and they could be very substantial.”
KBRA estimates that the default rate in the private credit market will jump to 3 per cent in 2025, up from 1.9 per cent at the end of last year.
“With the expected pace of rate cuts slowing, companies at the bottom end of our credit assessment distribution could face a reckoning in 2025,” said KBRA analysts John Sage and William Cox. Moakes also highlighted the growing might and reach of large, diversified, US-listed alternative investment managers — and said their huge growth might not benefit underlying investors in the funds.
“They’re great businesses, and they’ll have a private equity arm, and they’ll have a private credit arm, and they’ll probably have a hedge fund division and a real estate division . . . and [their funds] are lending to each other,” he added. “It’s all a bit circular.”
“The risks are going up . . . You can construct all kinds of cataclysmic scenarios where they take each other down, but actually, they won’t, because what they’ve done is very clever,” he added. “This stuff is all sitting in LP [fund] vehicles. So the liability is all with the investors.”