The private credit industry has seen a significant increase in recent years, leading to a whole host of concerns regarding its resilience in times of economic downturn. One of the major worries is the lack of a large-scale downturn experienced by the industry, raising questions about its preparedness for a crisis and the implications for borrowers.
During JPMorgan’s Investor Day, Chairman and CEO Jamie Dimon acknowledged the competition posed by the migration of assets to the non-bank sector. However, he raised concerns about the impact on the United States as a whole when stating that borrowers who took private-credit loans may be left stranded in times of crisis. Dimon highlighted the difference in how banks and private credit firms handle loans during a crisis, emphasizing that private credit firms are required to book loans at par, regardless of market conditions.
In response to Dimon’s comments, Ares Management CEO Michael Arougheti defended the private credit industry, asserting that the risk of default is exaggerated. Arougheti pointed to Ares’ track record of investing $150 billion in the private-credit market with a remarkably low loss rate of one basis point over 30 years. He argued that private credit loans are no different from those held by traditional banks and rejected claims of increased risk in the private market.
Despite the industry’s defense, concerns about recovery rates in private credit remain. Federal Reserve data comparing default rates in private credit with traditional bank loans showed lower recovery rates for private-credit loans. This discrepancy is attributed to the higher exposure of private credit to sectors with lower collateralizable assets, such as software and healthcare services.
Private credit firms like Ares Management argue that the industry’s growth actually reduces systemic risk by shifting assets to companies with lower leverage and more stable financing structures. However, the interconnectedness of private credit with traditional banking poses challenges in the event of an economic downturn. JPMorgan’s position as a major financier of private-credit portfolios raises concerns about the potential impact on the broader financial system.
As the private credit industry continues to expand, concerns about its stability and resilience in the face of economic challenges persist. With increased interconnectedness with traditional banking and potential vulnerabilities in recovery rates, the industry may face significant challenges in managing a possible downturn. It remains to be seen how private credit firms will navigate these risks and protect both borrowers and investors in times of crisis.