Seemingly absent from the myriad discussions involving the Middle East war, soaring fuel prices and accelerating worries over a potential global recession is practically any mention of the turmoil in the private credit market.
This was a major talking point among financial pundits prior to the start of the Iran-Israel affair, but it has since been swept under the rug as mainstream news headlines are now heavily tilted toward all things Middle East.
But not quite everyone has forgotten about the private credit conundrum. On a recent episode of Bloomberg’s Odd Lots podcast, Ozan Tarman, Vice Chair of Global Macro at Deutsche Bank, said this concerning this situation: “[Credit lending] headlines are not going away. If anything, they’re definitely hiding behind Iran at the moment. It would be almost all that we would be talking about, especially in the U.S., if it wasn’t for Iran.”
Expounding further, he said, “If people cannot take their own money away from private credit and have to sell something liquid, then watch out for public credit...and of course watch out for public equities, so I’m watching that space very carefully.”
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That said, official denials of a brewing private credit storm continue to circulate. At a recent Morgan Stanley conference, top investment bankers mostly downplayed the severity of the problem, with some stating their banks had little or no exposure to the troubled areas of private credit lending. Tellingly, however, when asked if he would take advantage of the pullback in the private credit market to increase lending to these firms, Barclays’ CEO C.S. Venkatakrishnan (commonly known as “Venkat”) responded with “unlikely.”
Deutsche Bank, meanwhile, continues to sound warnings over the global $3 trillion private credit market as a growing risk, highlighting potential “indirect credit risks” through interconnected portfolios, despite not seeing immediate major losses.
Source: KBRA DLD via Future Standard
Deutsche Bank itself currently has $30 billion in exposure, up 6% year-on-year, with one of the largest exposures to the sector among Wall Street banks. The bank did, however, acknowledge increasing investor concerns related to underwriting standards and fund redemptions, particularly as firms like Apollo Global and Ares recently capped withdrawals from private debt-related funds.
Meanwhile, a growing number of U.S. banks are raising borrowing costs for private credit fund loans “as doubts grow about the valuations given to some of their investments,” in the words of a March 31 Reuters article. Interest rates on such loans have increased by as much as two percentage points over the Secured Overnight Financing Rate benchmark, from around 1.8% points, since last November, Reuters said.
“The era of low rates for a sustained period of time seems like it is over,” said special situations lawyer Seth Kleinman in response to this, as quoted in the article.
Since most private credit loans are floating-rate loans, the higher rates could actually benefit them in the near term by boosting income, which may partly explain the equity market’s relatively subdued response to the private credit sector’s recent troubles. Over time, however, elevated borrowing costs can strain borrowers’ cash flows, particularly among highly leveraged companies, raising the risk of delayed defaults.
The Wall Street Journal recently elaborated further on this subject with the article, “Is Another Financial Crisis Lurking in Private Credit?” The takeaway from the article is that private credit is showing early signs of stress but is unlikely (for now at least) to trigger a full-scale financial panic similar to the 2008 credit crash since leverage is generally lower compared to pre-2008 bank lending.
WSJ acknowledged, however, that risks are growing since banks have more exposure to private credit than many realize, with the added problem of private credit being less transparent than traditional banking.
In view of these considerations, I’m continuing to monitor the private credit situation closely for subscribers of the Cabot Turnaround Letter for any signs of “seismic activity” that could translate into heightened risk for the broad equity market.
Right now, though, I see no indication that the sector’s volatility poses an imminent threat to stock investors.
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