Why concerns are growing over the private credit market

Private credit — or borrowing money from investors or money managers, rather than banks — is an increasingly popular way for companies to access capital and expand their business.

That market has grown fivefold since the 2008 financial crisis, according to the Federal Reserve, and now sits somewhere near the $2 trillion mark globally. In the last couple weeks, though, the private credit market has gone sideways, and economists aren’t exactly sure what to make of it.

After the financial crisis, regulation forced big banks to tighten up their lending practices. Elisabeth de Fontenay, a finance law professor at Duke University, said that made it harder for some companies to get loans.

“This has really created an opening for private credit funds to step in,” she said.

De Fontenay said private lending can be riskier than bank loans or corporate bonds. But Laura Veldkamp, a finance professor at Columbia University, said that’s part of their appeal.

“Typically, you’ll get a higher rate of return in private credit,” she said.

 Investors tend to have an appetite for that kind of risk.

“So you might have an endowment fund, you might have a wealthy person trying to achieve more diversification,” Veldkamp said.

As for the companies receiving those loans, Gerald Cohen — finance professor and chief economist of the University of North Carolina at Chapel Hill’s Kenan Institute of Private Enterprise — said a significant amount has been in the software industry.

That shouldn’t be a surprise, he said. Software firms are often startups, too small to sell bonds or meet requirements for bank loans. Cohen said the problem right now is that software companies are threatened by the development of artificial intelligence.

“Is AI just gonna be able to develop all our software?” he asked. “Do we need software companies anymore?”

Those fears caused share prices for private credit managers to drop in recent weeks. By itself, that’s not a huge deal, Veldkamp said.

“(But) maybe this is the canary in the coal mine,” she said.

There could be ripple effects, Veldkamp said. Big banks — those considered too big to fail — sometimes lend to the same private credit managers who make those riskier loans. And while a private credit collapse isn’t imminent, she said there are still concerns.

“The concern is that this is just the beginning and that this is a more widespread phenomenon,” Veldkamp said.

But, she said, it’s still too early to tell.

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