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The booming private credit sector is inspiring a rich lexicon of alarm. For some time, market watchers have described the alternative asset class — which has grown to around $3tn globally — as a “ticking time bomb.” Recent turbulence has added to the colourful language. After the collapse in September of US car-parts maker First Brands and auto-lender Tricolor Holdings, which had both taken loans from nonbank financial institutions, JPMorgan chief Jamie Dimon warned that “when you see one cockroach, there are probably more.” Andrew Bailey, governor of the Bank of England, said last month the bankruptcies could be a “canary in the coal mine”.
Analysts are taking note. To extend the roach analogy, they are asking whether recent problems in private credit are isolated pests or signs of an infestation. For now, calm prevails. The tremors in the US auto industry are being blamed largely on company-specific factors. There is some comfort that, despite rapid growth, private credit still accounts for a small fraction of outstanding corporate debt in America. Lending is often channelled through funds with limited redemption risks and moderate leverage, according to Fitch Ratings. In the US, broader economic conditions — from falling interest rates to healthy corporate balance sheets — are also expected to provide support.
But even if the risks of an imminent systemic shock appear limited, recent warnings have at least drawn attention to several troubling trends that investors and supervisory bodies should watch closely.
First, the real economy’s exposure to private lending — though small — is rising. In the US, loans to non-depository financial institutions account for more than 10 per cent of total bank loans, almost three times the exposure a decade ago, according to Moody’s. A particular concern is insurers’ growing investments in the opaque asset class, which could leave policyholders exposed if things go wrong. Efforts by private lenders to ease access for retail investors widens vulnerabilities further, while increased involvement in data centre financing ties the market more closely to the artificial intelligence boom.
Second, questions about lending standards are mounting. As the Financial Times reported on Monday, the rise of smaller, specialist rating agencies has sparked fears that private capital groups are “shopping” for the most favourable credit scores. Others point to the growing use of “payments-in-kind” — which allow borrowers to defer interest payments — as evidence of mounting strain and weakening loan quality. Fraud suspicions connected to some of those “cockroach” incidents are evidence of poor underwriting standards, critics say.
Third, although the global economy has shown resilience, it remains fragile. As it is, some investors worry that narrow spreads in public credit markets fail to capture real default risks. The uncertainty surrounding US President Donald Trump’s policy agenda adds to the unease. His administration’s push for broader financial deregulation could fuel further risk-taking just as signs of froth in both equity and credit markets are becoming harder to ignore.
Today’s boom in private markets has its roots in the tighter regulation placed on banks following the global financial crisis. That has channelled more credit through the less transparent and less regulated shadow banking system. Private markets have since played an important role by raising competition with traditional lenders, extending credit to innovative businesses and widening investment opportunities. Banks are even calling for looser rules to counter their surge. But as more money floods into the sector, vigilance must also keep pace. Regulators need to push for greater transparency and better data sharing across jurisdictions to monitor lending standards and economic linkages. Investor scrutiny will be just as vital. Indeed, even if recent warnings seem overblown to some, the risks they highlight are real and growing.