(Bloomberg) -- Watchdogs are concerned about the “substantial” risk to investors in the private credit market after it emerged that almost 40% of funds don’t have skin in the game.
The decision by so many managers to avoid putting their own capital into the vehicles creates an “incentive misalignment,” the Bank of International Settlements said this week. The risk is that industry players could prioritize their profit over investors’ returns.
Private credit has grown rapidly into a $2.1 trillion industry, according to BIS estimates, after banks pulled back from certain types of lending following the financial crisis. Now, supervisors are growing concerned about the effects the sector could have on traditional lenders because many of the managers haven’t been through a credit cycle. And that, in turn, means risks behind manager selection may not be clear.
There are also increasing worries about valuations, with only 40% of private credit funds reporting data to the US Securities and Exchange Commission using third-party marks.
Watchdogs including the Bank of England have spent months examining how private markets interact amid wider concerns about the risks that shadow banking, which encompasses everything from insurers to money market funds, pose to the financial system.
Symbiotic Relationship
Private equity’s being scrutinized after a jump in the cost of the floating-rate that debt managers typically used to secure deals made repayments more difficult. About 78% of private credit deal volume in the US goes to PE-owned firms, according to the BIS report. In Europe, regulators now plan to seek more transparency around how shadow banks interact with one another.
“The part we don’t know is what goes on” when “non banks are interacting with other non bank financial institutions or ultimately with the borrowers,” Jose Manuel Campa, the head of the European Banking Authority, said in an interview with Bloomberg Television. “That’s the bit we have to understand better, and have better discovery.”
The EBA is concerned that off-balance sheet exposures could become a problem for banks if large non banks need to access credit lines simultaneously.
In addition, traditional lenders can cut their average capital demands by extending short-term loans to shadow banks, which typically attract a more favorable regulatory treatment than the consumer and real estate lending that make up the majority of their loan books.
The danger is that shadow banks could then buy up their lenders’ bonds and use them as collateral in the repo market, creating a “circle of exposures” and leading to “both on and off-balance sheet links between the two types of lenders,” the EBA said.
“Such two-way links in bank issued debt securities would give rise to a funding liquidity risk for both parties.”
Private Credit
More stress will emerge in private credit, though the path of interest rates will be critical, Wayne Dahl, co-portfolio manager for Oaktree’s global credit and investment grade solutions strategies, said on Bloomberg’s Credit Edge podcast.
“There’s just a lot of uncertainty that we’re going to see in the private credit market,” he said. “It’s difficult to always get that full picture of exactly what’s going on.”
Week in Review
- Lenders to risky, debt-laden companies are increasingly demanding protection from financing maneuvers used to undercut creditors when times get tough.
- The Wall Street professionals who underwrite blue-chip US corporate bond sales are bracing for a busy summer, instead of the usual slowdown in July and August.
- Blackstone Inc. is leading a €1.35 billion ($1.45 billion) private debt financing to support the buyout of property-management software maker Aareon AG by TPG Inc. and Canadian public pension fund CDPQ.
- Troubles in the electric vehicle industry are spreading into debt markets, where falling values for used cars are causing challenges that could make it harder for customers to get loans.
- Dollar loan sales for the first half across Asia excluding Japan tumbled to their lowest since 2010 as higher borrowing costs in the greenback deterred companies, which opted for other financing routes or looked to defer such plans if possible.
- Japanese companies are selling an unprecedented amount of foreign-currency debt, as robust demand for credit globally keeps spreads near their tightest in a decade.
- Rising speculation of an interest-rate hike by the Bank of Japan as early as this month is sapping investor demand for 10-year notes in a busy corporate bond market and driving up premiums on new issuance.
- A growing number of Japan’s mid-cap companies are considering buyouts and other strategic options, according to Mizuho Financial Group Inc., which is seeking to increase lending and advisory services to the sector.
- Italian drug-maker Recordati SpA plans to raise at least €1.5 billion ($1.6 billion) from the sale of junk bonds to push out debt maturities.
- SVB Financial Group secured a more than $600 million cut to its potential tax bill, boosting some bonds tied to the bankrupt former parent of Silicon Valley Bank and removing an obstacle in its path to repaying creditors in Chapter 11.
- A group of lenders to Altice USA Inc. has agreed to band together in an effort to make it harder for the troubled company to pit creditors against each other.
- Telecom tycoon Patrick Drahi’s planned sale of a controlling stake in his French fiber optic company XpFibre is stalling due to disagreements over price. The planned sale is part of Drahi’s effort to cut the debt load in his telecom empire.
On the Move
- Restaurant chain FAT Brands Inc. has hired structured credit investor Jordan Chirico as head of debt capital markets as it plans to refinance at least one of its outstanding bonds.
- HSBC Holdings Plc is slowing down hiring and asking investment bankers to rein in their travel and entertainment expenses as outgoing Chief Executive Officer Noel Quinn looks to curb costs at Europe’s largest lender.
--With assistance from James Crombie, Kat Hidalgo, Laura Noonan, Guy Johnson and Dan Wilchins.
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