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The abrupt collapse last year of several U.S. companies funded through private credit has thrust a rapidly expanding and less transparent sector of Wall Street lending into the limelight. Private credit, also known as direct lending, encompasses loans extended by nonbank institutions. Although this practice has existed for decades, it gained traction following the 2008 financial crisis due to new regulations that deterred banks from dealing with riskier borrowers. This sector is expected to balloon from $3.4 trillion in 2025 to an estimated $4.9 trillion by 2029. Recent bankruptcies in the auto industry, including Tricolor and First Brands, have sparked warnings from notable Wall Street figures about the potential dangers of this asset class.
Jamie Dimon, CEO of JPMorgan Chase, cautioned in October that credit issues are seldom isolated: 'When you see one cockroach, there are probably more.' A month later, billionaire bond investor Jeffrey Gundlach accused private lenders of issuing 'garbage loans' and predicted that the next financial crisis would stem from private credit. Although concerns have quieted recently, the threat has not fully dissipated. Companies closely linked with this asset class, like Blue Owl Capital, along with alternative asset giants Blackstone and KKR, remain substantially below their recent peaks in value.
The Rise of Private Credit
According to Moody's Analytics chief economist Mark Zandi, private credit is 'lightly regulated, less transparent, opaque, and it's growing really fast, which doesn't necessarily mean there's a problem in the financial system, but it is a necessary condition for one.' Advocates of private credit, such as Apollo co-founder Marc Rowan, argue that it fuels economic growth by bridging the gap left by banks, offering investors strong returns, and enhancing the resilience of the broader financial system. Furthermore, pensions and insurance companies with long-term liabilities are considered better sources of capital for multiyear corporate loans than banks, which are funded by more unpredictable, short-term deposits.
However, reservations about private credit are understandable, particularly when viewed in light of its characteristics. Valuations of private credit loans, often assigned by the asset managers lending them, can be skewed to postpone acknowledging borrower difficulties. Duke Law professor Elisabeth de Fontenay notes that while private credit's lenders are incentivized to monitor emerging problems, they might also attempt to obscure risks if they believe a solution could be imminent.
De Fontenay expresses concern over the difficulty of determining if private lenders accurately assess the value of their loans. 'This is a market that is extraordinarily large and that is reaching more and more businesses, and yet it's not a public market,' she remarked. 'We're not entirely sure if the valuations are correct.' For example, in the November collapse of the home improvement firm Renovo, BlackRock and other private lenders valued its debt at 100 cents on the dollar until shortly before reducing its worth to zero.
Defaults on private loans are anticipated to increase this year, particularly among less creditworthy borrowers, as stated in a Kroll Bond Rating Agency report. Moreover, private credit borrowers increasingly use payment-in-kind options to delay defaults, based on data from valuation firm Lincoln International cited by Bloomberg. Ironically, despite being rivals, part of the private credit expansion has been bank-funded.
Finance Focus