Fears of systemic risk from private credit are overstated, according to UBS Asset Management.
Joe Sciortino, head of private credit in unified global alternatives at the asset manager, eschewed concerns around the sector being a potential bubble.
In fact, he argued that private credit actually may play a stabilising role in the financial system, especially during period of market stress.
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“In times of stress, lenders have multiple levers to pull in order to work with borrowers to manage through challenging environments,” he said in an analysis. “While these actions may temporarily reduce cash flows, they can also provide necessary relief to borrowers, securing them the time to recover and stabilise their businesses.
“In addition, higher base rates provide higher cash flow and interest income to lenders compared to prior years. Concerns around private credit being a potential bubble or posing financial systemic risks are, in our opinion, overstated.”
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Sciortino noted particular concerns around payment-in-kind (PIK) income, which has been a focal point in the media recently. These structures allow struggling borrowers to make interest payments in a form other than cash, most commonly by adding to payments owed to the total debt.
Some industry onlookers have argued that the rise in usage of PIK is a sign of increasing stress in the market and presents higher risks for lenders.
But Sciortino highlighted that PIK represents less than 10 per cent of income for direct lending business development companies (BDCs) in the US, and that “there is a reasonable amount of dispersion by BDC in terms of the trends of total PIK income for a given portfolio.”
However, the private credit executive underlined the importance of enhanced monitoring of PIK components and interest coverage ratios to maintain a well-balanced portfolio, as well as rigorous credit selection and manager due diligence.
“We further observe that private credit funds typically have lower leverage than traditional banks and exhibit better asset and liability matching, and often include protective gating features within their fund structures,” he said.
“This can offer more stability compared to the daily liquidity risks associated with banks. Therefore, we believe the rise of private credit could actually be a stabilising factor for the financial system. However, it is crucial to ensure investors are well-informed about the liquidity and other associated risks when investing in private credit.”
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Private credit professionals have come to the defence of the sector lately, amid concerns of how default rates will fare in an increasingly challenging macroeconomic environment.
Apollo Global Management president Jim Zelter, speaking at HSBC’s investment conference in Hong Kong on Thursday, said that private credit is “not a bubble” and that he did not think adverse economic conditions would trigger “massive losses” in the sector.
“The biggest question I get from everybody around the globe is, is private credit a bubble?” said Zelter, cited by the Financial Times. “And I would say it’s not a bubble, but it’s certainly been long in the tooth in the cycle.
“Bubble means there’s very much irrational actions, and while I think there are folks that are probably taking [a] more aggressive portfolio construction than I would take, I don’t think it’s a bubble where you’re going to find the massive losses that you saw in other bubbles since I’ve been around.”
