Why are people suddenly talking about ‘private credit’?

You may have seen headlines about ‘private credit’ recently. Some suggest there is trouble in this corner of the market, which could disrupt the wider banking system. Others think it is a storm in a teacup.

But what actually is private credit? And do you need to be worried? 

What is private credit?

Private credit is a type of business loan that does not come from a bank. Instead, companies borrow from private lenders, such as asset managers and private equity firms, using money provided by investors.

It is most commonly used by medium-sized companies, although larger businesses also rely on it. The loans are negotiated privately and are not traded on public markets.

Once a niche pocket of the financial system, the private credit industry is now worth an estimated $2 trillion. Demand has surged since the 2008 financial crisis, as banks face tighter restrictions on who they can lend money to. Private lenders have stepped in to fill the gap.

Why are people worried?

Software firms make up a large portion of private credit borrowers. Rapid developments in artificial intelligence (AI) mean these firms could come under pressure - increasing the risk they will be unable to repay their debt. People are on high alert for news of default.

AI fears - plus volatility elsewhere - have prompted some investors to pull their money out of private credit funds. This is why asset managers such as Blue Owl, Cliffwater and BlackRock have been hitting the headlines. Many of these funds are only ‘semi liquid’ however, and managers have been restricting how much money is withdrawn. This has further rattled the market.

There are other factors too. Much of the growth in private credit came when interest rates were much lower than they are today - and when leverage was high. If the Middle East conflict persists, and interest rates stay higher for longer as a result, there is a risk that default rates will rise.

Where do personal investors come in?

The private credit market is dominated by institutional investors, such as pension funds and insurers, which are drawn to the high yields and diversification benefits. Very wealthy individuals can also invest via funds known as ‘business development companies’. Most retail investors have very limited exposure, however.

The bigger question is whether problems in private credit could spread more widely. Views differ. Some argue the market is relatively self-contained and not large enough to pose a systemic risk. In other words, even if major problems did emerge – and they haven’t done yet – the impact on the broader financial system would be small. 

Others fear that stress could spill over into the broader financial system, and impact traditional banks. The opacity of private markets is a particular concern. When banks lend money, they have to report to regulators. Similarly, publicly traded bonds are subject to a great deal of investor scrutiny. In private markets, however, problems can remain hidden.

For now, though, it is a case of wait and see. Default rates have not shot up; we are still in the early stages of the AI story; and a recent study suggests the systemic risk posed by private credit is low.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of financial adviser or an authorised financial adviser of your choice.