by Finance is always alive with risk, but if you had to put your finger on where the next big crash is waiting to happen, it’s called “private credit”.
So if you can tear yourself away for a moment from the hectic minutes of an election campaign that seems to have only one possible outcome, read on.
Anytime a financial sector grows very quickly, alarm bells should start ringing, and this one is growing like tapestry.
Last week, Goldman Sachs announced that its private credit investment asset management arm had raised an additional $13.1bn (£10.3bn), bringing the funds it now devotes to this particular asset class to $20bn.
He is not alone. Blackstone, KKR, Apollo, Oaktree, Uncle Tom Cobley and all – almost every money manager of global importance is piling in.
According to Bank of England estimates, leveraged lending and private credit combined have almost doubled over the past decade. Within that, private credit has grown even faster – quadrupling since 2015 to around $1.8 trillion worldwide. Given the limited nature of the data available, the total exposure is likely to be much higher.
Private credit, or private debt – sometimes referred to as the “shadow banking” sector – is an umbrella term for non-bank lending, and encompasses a very diverse group of both providers and types of credit.
Since the collapse of the banking system during the 2008-10 financial crisis, non-bank forms of finance have emerged, and today account for around half of all UK and global financial sector assets.
Somehow or another, finance always finds a way. When the banks stopped lending, the breach of private credit increased, compensating in part for the contraction in traditional forms of credit and the mountain of restrictive regulation that followed.
Call it the principle of “waterbed” finance; push down in one area, and it rises up somewhere else. Regulators are always one step behind. While they are busy bracing the system against the latest disaster, markets will always be planting the seeds for the next one on new, less transparent and unsupervised pastures.
In a recent speech, Lee Foulger, the Bank of England’s director of financial stability, strategy and risk, estimated that such non-bank finance was responsible for almost all of the £425bn net increase in lending to UK businesses since the financial crisis. .
This could of course be seen as a good thing, in that private debt providers have at least kept credit growing. On the whole, the mainstream banks have therefore welcomed the competition, which has insulated them from further costly write-offs by keeping many struggling companies alive.
Private credit has also provided alternative sources of finance for today’s many technology start-ups, where banks are reluctant to lend since the vast majority of such ventures have a lifespan of no more than a few years.
Prudential regulators are similarly ambiguous; they only understand too much about the risks, but are loathe to compromise an important potential growth dynamic and a ready source of finance for companies that might otherwise struggle to find it.
Private credit is thus widely seen as a useful shock absorber and – in an era of deregulation of banking – as an important alternative to banks as an enabler of economic growth.
But the dangers are all too obvious. Another of the enduring characteristics of finance – the search for yield – has fueled the growth of private credit.
Extremely low interest rates have made investors more risk averse as they seek higher rates of return.
When something looks too good to be true, it usually is, and that’s exactly what comes back to private credit that can be as high as teenagers.
As the banking sector has evolved over and over again, most reputable companies can borrow everything they need at much lower interest rates, so you have to ask yourself what kind of enterprise desperate enough to agree on debt servicing costs. .
Arrangement fees also tend to be highly penalized, giving financiers an added incentive to promote this type of loan.
Providers argue that the high cost of credit is a reflection of the heightened nature of the risk, but it still seems like a racket.
One increasingly popular practice is “amend and extend” (M&E), in which lenders agree to push back the maturity of a loan, usually in exchange for an even higher yield. “Payment in kind” (Piks) practices, in which borrowers with poor cash flow issue new debt to meet interest payments on old debt, are also becoming widespread.
This is the Ponzi-type loan in which our old friends, the credit rating agencies – top players in risk assessment standards that are deteriorating due to the financial crisis – are often involved again by assigning investment grade status.
As one seasoned credit analyst told me: “Write what you like about private credit, but I would strongly advise you not to invest in it.”
The following example tells its own story. According to financial services company Morningstar, Blackstone’s recent loss on the sale of 1740 Broadway, a nearly vacant 26-story office building near Manhattan’s Columbus Circle, was so great that it wiped out several tiers of bonds, including some of the AAA-rated top. tranche.
The $40m loss on triple A-rated credit is the first such failure in this cycle. There will definitely be more.
But does it matter if investors lose their shirts on credit exposures like this? Or in other words, are such losses systematically important? Well yes, they might be.
It is true that the banking system itself is largely insulated from losses in private credit. Banks often lend to private credit providers, but they almost always have a first charge on the assets, so they are unlikely to be adversely affected even by a widespread private credit crunch.
But insurers and pension funds have such illiquid assets, with significant unrealized losses already in some cases. These are highly regulated institutions, but savers may be fooling themselves into thinking their money is safe.
What makes things even more dangerous is the fragmentation of the world economy pressure from rising geopolitical tensions international efforts to achieve better standards of global regulation are already severely hampered.
The post-financial crisis reform agenda has faded and is now virtually dead.
Furthermore, the kind of global response to the financial crisis that Gordon Brown was able to galvanize back in 2009 is unlikely to survive in today’s much more fraught world.
Even if it were politically feasible, governments are already too fiscally stretched to bail out a second time. It is as if no lesson has been learned from the events of almost 16 years ago.
