RUTH SUNDERLAND: Private credit score market is the trillion-dollar debt timebomb

The Iran conflict is adding to the nervousness surrounding the multi-trillion-dollar private credit market.

The sector mushroomed in the aftermath of the credit crisis of 2008, when regulators clamped down on mainstream banks to stop them from ever again saddling taxpayers with a huge bill for their reckless lending.

That did not, however, stop risky borrowers from wanting money. Nor did lenders lose their appetite for charging said borrowers juicy high interest rates.

So instead of disappearing, the market just went elsewhere: to non-bank providers of private credit, such as insurance companies, asset managers and specialist funds.

As the name suggests, such loans are negotiated privately. They sit largely outside the regulatory framework governing banks. This makes it harder to know exactly how big the problems in the market might be.

Private credit started out as relatively small and niche but has grown rapidly. Too rapidly, in the eyes of some observers, who fear it could be the catalyst for a fresh financial crisis.

Rapid expansion: The multi-trillion-dollar private credit market mushroomed in the aftermath of the credit crisis of 2008

Jitters about private credit are linked to those over AI: it has been a big source of funding for data centres and other new infrastructure. It has also lent heavily to software firms, which have been subject to scares that their business models may be undermined by AI tools.

Many borrowers are heavily indebted private equity-backed companies, where default risks have been rising and where large numbers face a refinancing wall over the next two years. The situation in the Middle East could exacerbate such fragilities. Higher oil prices threaten to feed through into inflation, which in turn means pressure on central bankers to keep interest rates higher for longer.

Corporate earnings are susceptible to rising energy costs and already straitened household finances will feel a bigger squeeze.

If the war is over quickly, it may not inflict lasting damage on the real economy in the US. But it increases vulnerabilities in the private credit sector, where borrowers are typically more highly leveraged than those at mainstream banks.

The boss of Swiss-based Partners Group, one of Europe’s biggest private capital players, said last week that default rates on loans could double in the next five years.

In the US, the collapse of sub-prime vehicle lender Tricolor and auto parts maker First Brands prompted Wall Street titan Jamie Dimon, the veteran boss of JP Morgan, to speculate that more such ‘cockroaches’ would emerge.

Some US private credit funds, including ones at Blue Owl and Blackstone, have been hit by demands from investors to pull their money out.

In the UK, one possible canary in the coal mine is the collapse of specialist buy-to-let and bridging lender MFS, amid allegations of fraud. It has left Barclays nursing potential losses of £600m and Santander facing £200m to £300m, demonstrating contagion to the conventional banks.

The Bank of England was worried enough prior to the MFS debacle to have ordered an industry stress test to see whether private credit problems are a systemic threat.

The big guns on Wall Street say it is not, or at least not yet. Goldman Sachs boss David Solomon opined that despite a ‘bunch of idiosyncratic events’, most private credit portfolios are fine, because the US economy is robust.

In strikingly similar language, Citigroup chief executive Jane Fraser said there might be ‘idiosyncratic risk’ from some operators, but no systemic issue at the moment. Maybe so. But financial crises have a habit of beginning with what bankers dismiss as idiosyncrasy.