The sudden decline last fall of several American firms supported by private credit has cast a spotlight on this rapidly expanding and opaque sector of Wall Street lending. Private credit, or direct lending, is conducted by nonbank institutions and gained popularity after post-2008 financial crisis regulations discouraged banks from engaging with riskier borrowers. This market is projected to grow from $3.4 trillion in 2025 to an estimated $4.9 trillion by 2029. The September bankruptcies of auto-industry companies Tricolor and First Brands have prompted some prominent Wall Street figures to express concerns about the asset class. In October, JPMorgan Chase CEO Jamie Dimon noted that credit issues are rarely isolated, stating, "When you see one cockroach, there are probably more." A month later, billionaire bond investor Jeffrey Gundlach criticized private lenders for making "garbage loans" and predicted that the next financial crisis could stem from private credit. Although fears around private credit have eased recently due to a lack of further high-profile bankruptcies or significant losses reported by banks, they have not disappeared entirely. Companies closely associated with private credit, like Blue Owl Capital, along with large alternative asset firms Blackstone and KKR, are still trading well below their recent peak values.
The rise of private credit
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," remarked Mark Zandi, chief economist at Moody's Analytics, in an interview. Advocates for private credit, such as Apollo co-founder Marc Rowan, argue that the rise of this lending form has bolstered American economic growth by plugging gaps left by traditional banks, provided investors with healthy returns, and enhanced the broader financial system's resilience. Large investors like pensions and insurance firms, which have long-term liabilities, are considered better sources of capital for multi-year corporate loans than banks with short-term deposits, which can be unpredictable, according to private credit operators speaking to CNBC. Nonetheless, concerns about private credit—mainly from the sector's competitors in public debt—are understandable due to its characteristics. Asset managers who provide private credit loans also assess their value, potentially incentivizing them to postpone acknowledging any borrower issues.
"The double-edged sword of private credit" lies in lenders having "really strong incentives to monitor for problems," explained Duke Law professor Elisabeth de Fontenay. "But by the same token … they do in fact have incentives to try to disguise risk, if they think or hope that there might be some way out of it down the road," she added. De Fontenay, who has examined the effect of private equity and debt on corporate America, voiced her main concern about whether private lenders are accurately assessing 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 commented. "We're not entirely sure if the valuations are correct." In the November collapse of the home improvement firm Renovo, for instance, BlackRock and other private lenders rated its debt at 100 cents on the dollar until it was shortly marked down to zero. According to a Kroll Bond Rating Agency report, defaults among private loans are expected to increase this year, particularly as stress signals appear among less creditworthy borrowers. Private credit borrowers are increasingly resorting to payment-in-kind options to avoid defaulting on loans, reports Bloomberg, citing valuation firm Lincoln International and its own data analysis. Ironically, despite being competitors, banks themselves have partly funded the private credit boom.