Until recently, private credit – a purportedly new asset class – has been one of Wall Street’s fastest growing investment products. Companies considered too complex for traditional bank lending or too small to access public bond markets were increasingly turning to specialist private credit lenders for funding. These lenders have historically pooled capital from institutional investors and provided financing to private borrowers, earning above public market interest rates in return. In the space of just a few years, the global private credit market has ballooned to around $3 trillion in size, larger than the US public high‑yield bond market and almost twice the value of the sub‑prime market ahead of the 2008 financial crisis. Encouraged by this success, private credit managers have begun selling products to retail investors.
Though supposedly a new asset class, we suspect there is less to private credit than meets the eye. It is possible that some niche issuers might be willing to pay higher interest rates in return for customised loan terms. However, we think it more likely that, for the most part, the higher yields on offer simply reflect less creditworthy borrowers and significantly reduced liquidity (the ability to buy or sell the bonds at a reasonable price, at will).
A series of negative headlines in the past few weeks suggests the private credit market is beginning to creak. For example, BlackRock has completely written off a private credit loan that it valued at par just three months ago. Other managers have also been forced to write down the value of some loans, with questions emerging around the accounting and disclosure standards of certain large private credit borrowers – and the due‑diligence and valuation practices of lenders – in this unregulated market.
With investors taking note of JPMorgan CEO Jamie Dimon’s warning that “when you see one cockroach, there are probably more” – a reference to the recent high profile private credit backed bankruptcies of Tricolor and First Brands Group – private credit funds have received record redemption requests. This has exposed the liquidity mismatch inherent in selling private loans to retail investors. In response, a number of prominent private credit funds, including those managed by Blackstone, Blue Owl and BlackRock, have suspended redemptions, leaving investors unable to access their capital.
With funding drying up, borrowers needing to refinance their debt – as well as those struggling to make regular interest payments – have increasingly resorted to ‘payment‑in‑kind’ (PIK) loans. These arrangements allow companies to defer cash interest payments by adding to the outstanding loan balance instead, increasing leverage and creating an even larger debt burden to be repaid at maturity – assuming the company survives that long.
Fig. 1: Year-to-Date Returns of Private Market Asset Managers
Against this backdrop, listed private market asset managers, particularly those with large credit arms, have seen their share prices fall sharply over the year‑to‑date (see Fig. 1).
Reports of rising defaults and the withdrawal of funding across the private credit market, together with surging oil prices, are reminiscent of conditions seen ahead of the financial crisis. Bolstering the comparison, the role played by banks in providing leverage to private credit managers increases the risk that problems could extend beyond the asset class itself. Though the opaque nature of the private credit market makes it difficult to assess the full scale of the risks involved, recent headlines and their implications are, at the very least, a cause for concern.
We have steered clear of private credit, believing the flood of assets into this part of the market has likely encouraged and masked a lax approach to risk management. Instead, the fixed income component of Heronsgate portfolios is skewed in favour of high‑quality, liquid bonds where valuations are transparent and the risk of default is low.
