Private Credit Is Being Threatened by a Cocktail of Risks
(Bloomberg) -- Private credit more than doubled in size from 2019 thanks to interest rate hikes that made its floating-rate debt more attractive to investors. Now, a Federal Reserve interest-rate cut is adding to the headwinds hampering the breakneck growth of the $1.7 trillion industry.
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Lower benchmark rates will make fixed income, which locks in returns, more attractive to investors than variable rate. That’s set to become a more pressing issue after the Fed projected further easing later this year.
Regulators also have the industry in their crosshairs after growing concerned about the spillover impact any crisis could have on banks, which provide loans to private credit managers to add more firepower to their pools of investor commitments. On the fundraising side, institutional capital allocations are flatlining, falling oil prices may affect inflows from the Middle East and new US measures could make it harder for insurers to invest in the asset class.
The other big potential threat is a US recession. A soft landing for the economy is the central case, but a deeper slowdown would spell trouble, squeezing the pipeline of money, reducing the appetite for deals and increasing the risk of borrowers failing to repay.
According to Patrick Dennis, co-deputy managing partner at Davidson Kempner Capital Management, defaults in private credit are about 3-5%, partly due to covenant breaches and modifications.
“Defaults are kicking up in all three areas of the market that we focus on,” he said at the Milken Institute Asia Summit Thursday. “From a severity perspective, this is the biggest risk in the market that we’re trying to evaluate.”
Oil Money
Private markets fund managers have been flocking to the Middle East in recent years in an attempt to raise additional capital to deploy. That effort could become more challenging if oil prices continue to slip lower.
“A prolonged spell of depressed oil prices would inevitably weigh on the rate at which institutional investors in the region deploy capital into private markets,” said Cameron Joyce, head of research insights at Preqin. However, he noted there will still be appetite because many private credit allocations are below long-term targets.
One upside to lower rates is that they may encourage more dealmaking, which would provide more opportunity to deploy capital, as long as that’s accompanied by a soft landing that doesn’t lead to widespread defaults.
But there’s competition for business as traditional lenders fight to steal back buyout business after private credit made inroads into that area, which had long been a lucrative source of fees for investment banks such as Goldman Sachs Group Inc. and JPMorgan Chase & Co.
Tougher Scrutiny
In the regulatory area, the Financial Stability Board is examining how private markets interact as part of wider investigations into shadow banking. The European Central Bank is pressing top lenders for details of their exposure to private credit firms and their funds, while the Bank of Japan is also keeping an eye on the links.
“The exposure of Japan’s financial institutions to global private credit funds are increasing, with a concentration towards some big players,” Hirohide Kouguchi, an executive director at the Bank of Japan, said in an article in Eurofi magazine. “We need to remain vigilant,” he added, citing systemic implications.
In the US, new rules from the National Association of Insurance Commissioners that go into force in 2026 will give regulators more leeway to discourage insurance companies from investing in private investments and other assets viewed as excessively risky.
The measures allow the NAIC to effectively assign its own ratings to a wider range of bonds and other securities owned by insurance firms — which could mean stricter assessments. That’s a blow to insurers, which depend on those ratings in order to invest in everything from slices of corporate debt to pools of consumer loans.
To help it with the work, the NAIC plans to enlist outside expertise so it can accurately assess ratings, according to draft documents circulated last month.
The rules are “going to give insurance companies pause in investing in some of the more aggressive forms of rated note structures for private credit or asset based credit,” said Manish Valecha, head of client solutions at Angel Oak Capital Advisors.
Any pullback by insurers would be a blow to direct lenders’ growth ambitions. The average allocation by an insurance firm to private credit has doubled since 2019 to 4%, according to data compiled by Preqin.
Insurance capital has been one of the drivers of private credit markets, although the quality of triple B portfolios, which are popular with that industry, can be variable, according to Dennis.
“If you start to see defaults in those portfolios, you could risk a regulator or regulators overreacting in the other direction which could create some technical market disruption that frankly we would welcome but could create some risk of contagion a little bit more broadly,” he said.
Deals
Banco Santander and Silver Point Finance have provided a $325 million private credit loan to Solaris Energy Infrastructure to help finance its acquisition of Mobile Energy Rentals
KKR & Co.’s capital markets arm led a $1.4 billion private credit loan for USIC Holdings, which the public utility provider used to repay broadly syndicated debt
UBS Group AG is leading a $1.15 billion financing package to support Vista Equity Partners’ acquisition of software company Jaggaer, beating out direct lenders who were also competing for the deal
Oak Hill Advisors has provided a $775 million private credit loan to help Carlyle Group Inc. finance its acquisition of auto parts distributor Worldpac
Carestream Dental Inc. has obtained $525 million of financing in a debt restructuring that will see investors including General Atlantic’s credit arm and Canyon Partners take a stake in the struggling dental equipment company
Private credit funds are in talks to provide at least €1 billion in payment-in-kind loans to help finance the potential buyout of pharmaceutical firm Stada Arzneimittel AG
Vista Equity Partners and Blackstone Inc. are asking private credit lenders for a $3.2 billion debt package to support their proposed acquisition of software maker Smartsheet Inc.
Tikehau Capital is arranging a unitranche loan for about €160 million to fund Cinven’s acquisition of a stake in French services provider Domia Group
Fundraising
An arm of Indian billionaire Uday Kotak’s group is planning to launch its first private credit fund this year
Silver Point Capital closed a $4.6 billion opportunistic credit fund, exceeding its target of $4 billion
Muzinich & Co. and Orion3, an Asian alternative investment platform, have launched an infrastructure and real assets private debt strategy
Job Moves
BlackRock Inc. is overhauling its private credit business as the world’s largest asset manager races to catch up to competitors in the booming market
Fidelity Investments has hired Lendell Thompson, a former director at Vista Credit Partners, as it continues expanding into the private credit market
Igor Kukhta joined Orrick Herrington & Sutcliffe as a partner in its finance team in Paris, representing private credit lenders among other clients
Ryan Kim joined Gibson Dunn as a private credit partner in New York
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--With assistance from Laura Noonan and David Ramli.
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