Private credit is facing a test and must “reset” as volatility and liquidity risks surface, although growth remains on track, according to Moody’s Ratings.
The ratings agency said that while private credit markets have typically been characterised by low volatility and premium returns, they are now facing “new challenges” that must be addressed.
In its latest sector in-depth report, Volatility will intensify focus on liquidity, transparency, Moody’s Ratings pointed to the recent semi-liquid fund redemption requests, which it said “underscore that volatility and liquidity risk are becoming a bigger part of this market”.
Read more: Moody’s downgrades outlook for $400bn BDC sector amid redemption pressures
“Even so, volatility will not derail growth, which remains supported by strong financing demand for data centers, energy transition, defense and asset-based finance,” the ratings agency added.
It said that the “growing tide” of semi-liquid fund redemption requests in recent months is a reminder that even private credit markets are vulnerable to volatility and liquidity risk, particularly the US direct lending market, “when investor sentiment sours”.
Business development companies (BDCs) run by Apollo Global Management, Ares Management, BlackRock and Blue Owl Capital have faced fund redemption calls from investors concerned about credit stress and portfolio valuations.
“While the European private credit market does not include BDCs and is less mature than the US, its direct lending market is also showing signs of asset quality weakening,” Moody’s Ratings warned.
Despite greater volatility to contend with, alternative asset managers remain “primed for growth”.
Read more: Private credit weathers scrutiny as managers reject crisis narrative
“Capital demand remains strong for infrastructure including data centers, energy transition and defense – with asset-based finance increasingly filling these needs with receivables finance and other contractual cash flow assets,” the ratings agency explained.
“Although some policymakers continue to focus on transparency and related risks given market opacity, regulators from the US to Australia also see private credit as a complement to public markets and means to spur growth.”
Moody’s Ratings also highlighted the “emerging challenges” facing direct lending specifically, citing the growth in weaker borrower credit profiles, while payment-in-kind (PIK) usage remains “elevated”.
“Refinancing risk, meanwhile, continues to build in sectors such as software and IT services, where BDCs have more exposure. As in other sectors, borrowers face renewed inflationary pressures alongside increasing AI-related business model disruption,” the ratings agency noted.
Against this backdrop, private credit will have to provide greater transparency, particularly as retail investors become a more important source of capital.
“Alternative asset managers will likely be focusing on improving disclosures to meet emerging demand and to improve longer-term confidence,” said Moody’s Ratings.
Read more: PIK usage in BDCs remains “broadly stable” despite software concerns
