The rising strain in the private credit market is a result of years of sloppy underwriting standards in lending, according to Pacific Investment Management Co.
"There is a reckoning going on right now," Christian Stracke, president at the $2.3 trillion asset manager, said in a March 10 podcast alongside Gregory Hall, the firm's head of U.S. global wealth management. "It's not just a crisis of confidence, it's a crisis of really bad underwriting."
The $1.8 trillion private credit market is witnessing an exodus of investors after some high-profile corporate blowups led to mounting concerns over loan quality and exposure to software firms, whose business models are being threatened by rapid strides in artificial intelligence.
In the latest sign of strains, JPMorgan Chase & Co. is restricting some lending to private credit funds after marking down the value of certain loans in their portfolios, according to a person familiar with the matter.
This week also brought news that Cliffwater LLC was coming under pressure, with its $33 billion flagship private credit fund facing redemption requests.
The latest developments come after BlackRock Inc. last week capped withdrawals from its HPS Corporate Lending Fund at 5% after investors sought cash of nearly double that amount. Just days before that, Blackstone Inc. allowed investors to redeem a record 7.9% of shares from its flagship fund, known as BCRED.
The squeeze will likely result in mid-single-digit defaults for a couple of years and investor returns dropping to as low as 6% from around 10%, across managers, Stracke said, adding however that he doesn't foresee a broader credit crisis.
The lack of transparency in the space means that because some loans are marked down to zero, some investors will "rush to assume that everything else is as bad," which isn't the case, according to Stracke.
"It seems unlikely that there's going be a spiral in terms of a credit crunch" as long as the U.S. economy is doing reasonably well and the Federal Reserve is inclined to cut rates or stay on hold, Stracke added.
But "if you're in the more problematic loans, whether they're private or traded bank loans, then it's going be very difficult for that borrower to refinance themselves," he said.
Pimco has been among the early critics of private credit. With record fundraising after the 2008 financial crisis, direct-lending vehicles are due for a stress test, analysts Lotfi Karoui and Gabriel Cazaubieilh wrote in a note earlier this month.
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