There are “accidents waiting to happen” in private credit because of looser lending standards and the vast amount of capital that has flooded into the sector, the chief investment officer of one of the world’s largest charitable foundations has warned.
The £37.6bn Wellcome Trust’s Nick Moakes told the Financial Times that big investors in such funds could suffer “very substantial” losses if the US economy eventually falls into recession.
“If the world gets a little bit more difficult economically, I think that there are some accidents waiting to happen in the private credit world,” said Moakes in an interview.
“If there is an issue within that whole ecosystem, there will be some quite high-profile investors, many of whom do have some kind of systemic importance, that will be quite badly damaged,” he added.
His comments come as rating agency KBRA warned on Tuesday that private credit borrowers that have struggled to pay off their debts may finally “face the music” this year, as a result of higher than expected interest rates weighing down on corporate balance sheets.
The firm, which analyses large swaths of the private credit market, said that while most loans would be paid off without a problem, borrowers whose “business models or capital structures have not adjusted to a higher rate environment” could begin to default on their debt.
As traditional banks have retreated from lending following the 2008 financial crisis, private credit, which finance a wide range of areas such as corporate acquisitions and consumer loans, has grown rapidly.
However, a growing chorus of central bankers, policymakers and some of Wall Street’s own top brass — including JPMorgan Chase chief executive Jamie Dimon — have flagged potential problems.
Moakes said that although private credit is “less dangerous” systemically than bank financing because leverage levels are lower, private equity managers have been able to borrow large amounts of money with minimal checks and balances.
“As [the private credit market has] become popular, it has sucked in an enormous amount of capital. That has meant that the lending standards that are applied in certain parts of private credit markets have diminished,” he said.
“It’s great for private equity borrowers,” he said. But for investors, “if you see a slower economy, particularly if you end up with a recession in the US eventually, which one day we will . . . there’ll be some haircuts [losses] to be taken, and they could be very substantial.”
KBRA estimates that the default rate in the private credit market will jump to 3 per cent in 2025, up from 1.9 per cent at the end of last year.
That forecast has been driven in part by a rapid shift in markets since Donald Trump was elected the 47th president of the US in November, with investors wagering the Federal Reserve will no longer be able to cut interest rates as much as previously expected.
“With the expected pace of rate cuts slowing, companies at the bottom end of our credit assessment distribution could face a reckoning in 2025,” said KBRA analysts John Sage and William Cox.
Moakes also highlighted the growing might and reach of large, diversified, US-listed alternative investment managers, and said their huge growth may not benefit underlying investors in the funds.
“There’s a series of very large asset management firms that have been created, and all power to their elbow,” said Moakes.
“They’re great businesses, and they’ll have a private equity arm, and they’ll have a private credit arm, and they’ll probably have a hedge fund division and a real estate division . . . and [their funds] are lending to each other,” he added. “It’s all a bit circular.”
Moakes said that, as alternatives firms have gone public, they face greater pressure to grow assets under management to maximise management fees, which may not be in the best interests of generating investment performance.
“As that space has sucked more and more capital into it, the expected return, logically, should have gone down,” he said.
“The risks are going up . . . You can construct all kinds of cataclysmic scenarios where they take each other down, but actually, they won’t, because what they’ve done is very clever. This stuff is all sitting in LP [fund] vehicles. So the liability is all with the investors.”
The Wellcome Trust, founded in 1936 following the death of pharmaceutical entrepreneur Henry Wellcome, exists today with the mission of funding scientific research in to mental health; infectious diseases; and climate and health.
It does not invest directly in private credit, but has a window into the industry because about a third of its portfolio is allocated to private equity.
Moakes, who will retire from the Wellcome Trust at the end of March, was speaking as the foundation reported results for the 12 months to September 30. The trust gained 15.6 per cent in US dollar terms, although in sterling terms the return was 5.2 per cent because of the strength of the pound.
It also reported a charitable spend of £1.6bn in scientific research. Over the past 10 years it has made 11.3 cent a year annualised in sterling terms.
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