As a result, Moody’s estimated that private credit in North America now stands at US$1 trillion, compared to US$1.4 trillion for the syndicated loan market.
“As private credit has flourished, risks have also increased,” the report said. “In this highly interconnected and deeply opaque market, a broad deterioration in the credit quality of borrowers can cause cascading disruptions in capital markets and in the broader economy.”
The interconnected nature of private credit stems, in part, from the fact that many of the large alternative asset managers who invest in private equity also target lending to these same companies, creating potential conflicts of interest and growing systemic risks.
“The opacity and growing breadth of the private credit market allows deterioration in asset quality to progress rapidly – under the regulatory radar – and to develop to such an extent that cascading risks cannot easily be or promptly corrected,” the report said.
Regulators monitor these types of risks in the traditional banking sector, with monitoring of bank leverage and exposures to risky assets, as well as liquidity and capital stress testing. However, the report notes, “there is no such oversight in the private domain, with risk assessment and mitigation left to the discretion of a few very large, rapidly growing asset managers.”
Moreover, the private credit market remains very opaque for regulators and the rest of the market.
When private credit managers run into problems with holding companies, they don’t have to provide a lot of information, “meaning the wider market could remain unaware of the accumulated risk until it is has already reached proportions with implications for wider funding markets,” the report said. .
Alternative asset managers also have fewer ways to offload these risks, he added.
“If any of these large asset managers are under duress, they could choose to suspend capital investments in the many small and medium-sized companies that depend on these funds to operate,” the report said.
Providers of capital to private equity and credit are typically insurance companies and pension funds and, to a lesser extent, endowments and family offices. However, the report also notes that retail investors are increasingly providing capital to private credit managers, which helps drive growth but also increases risk.
“A push to ‘detail’ private markets at the end of a credit cycle, with rising inflation and interest rates, could increase the transmission of rising private credit risks to broader financial markets,” warns The report.