The rapid expansion of private credit has raised numerous concerns within the financial industry. One of the most prominent issues is the lack of experience the industry has in handling a significant downturn. The absence of a large-scale crisis in the private credit sector has left many wondering how borrowers will fare when faced with a financial crisis.
During JPMorgan’s Investor Day, CEO Jamie Dimon expressed doubts about the resilience of private credit in times of crisis. He highlighted the potential risks associated with the industry’s lack of exposure to high interest rates, recessions, and high spreads. Dimon emphasized that while banks tend to work with borrowers during a crisis, private credit firms may struggle due to their fiduciary obligation to book assets at par.
In response to Dimon’s criticisms, Ares Management CEO Michael Arougheti defended the private credit sector, asserting that the industry has a proven track record of success. Arougheti cited Ares’ $150 billion investment in private credit over 30 years, boasting a remarkably low loss rate of one basis point. He refuted claims of increased risk in the private credit market, arguing that loans held by private credit funds are no different from those on bank balance sheets.
Ares’ Executive Chairman Tony Ressler argued that the growth of private credit could actually reduce systemic risk by allocating assets to companies with lower leverage and more stable financing structures. However, concerns remain about the interconnectedness between private credit and traditional banking, particularly as major financial institutions like JPMorgan increase their involvement in the sector.
The Federal Reserve’s analysis of default rates in private credit revealed lower recovery rates compared to traditional bank loans, such as leveraged loans and high-yield bonds. Despite the seniority of debt structure, private credit loans exhibited a higher loss given default. This raises questions about the industry’s ability to recover assets in times of financial distress.
The disparity in recovery rates can be attributed to the nature of collateral and tangible assets in private credit exposures. Sectors with lower collateralizable assets, such as software, financial services, and healthcare services, pose a greater risk of default. As private credit expands, the industry becomes more intertwined with traditional banking, potentially amplifying systemic risks.
As private credit continues to grow and evolve, the industry faces mounting pressure to prove its resilience in the face of economic downturns. The development of co-lending programs and increased capital deployment may offer some relief, but the true test will come when the next crisis hits. Whether private credit will weather the storm or succumb to the pressure remains to be seen.