Are there cockroaches still crawling around? Private credit fears are on the rise again as major funds reveal redemption pressures and banks move to cut their risk tied to the sector. It’s also creating a big dilemma for the industry, whose loan holdings and values are quite opaque and cannot offer immediate liquidity due to long-term investor capital. Private credit crisis is a result of ‘really bad underwriting’
Backdrop: The modern private credit industry opened for business after the global financial crisis, as all types of caps and limits were slapped on banks. Private credit firms emerged, and initially funded loans to businesses that weren’t able to access financing, but these higher interest rates ended up being highly attractive to many investors. As funds piled in from institutions, private equity firms like Blackstone (BX) and Apollo (APO) set up their own credit shops. Lending expanded to larger companies to fund everything from data centers to AI startups, and the products were eventually marketed to the retail crowd.
Eye on the shadows: As long as defaults are low, private credit can be a lucrative investment, with double-digit returns on lending. The problem is that there is not much insight into how the entire market is leveraged and how much risk is being taken on to underwrite new loans and capital. If things also go south in a sector that is highly funded by private credit, like an AI disruption to software companies, it can also have knock-on effects on the entire system. Apollo aims to mark private credit daily, eventually
Red flags first appeared in the fall after auto parts maker First Brands and subprime auto lender Tricolor Holdings went bankrupt. Things escalated last month, as redemption requests spiraled at direct lender Blue Owl (OWL), while BlackRock (BLK) later curbed withdrawals from one of its largest private credit funds. Now, JPMorgan (JPM) is reportedly marking down loan portfolios of private credit groups, and Morgan Stanley (MS) and Cliffwater have restricted redemptions at their multibillion-dollar private credit funds. Cliffwater gets redemption requests totaling 14%
Moment of reckoning? “Liquidity never matters until it matters” is the famous investing maxim, and so far, there has only been redemption pressure, not a full-blown private credit crisis. While banks have largely moved away from direct riskier lending, they do finance private credit firms indirectly in the form of business loans. As of now, it looks like broader panic has been contained, though there can be significant losses in the sector, as there are in any credit cycle.