The current financial landscape is putting a spotlight on a sector that for years was the goose that laid the golden eggs: private credit. After a period of rampant growth and returns that made everyone salivate, worrying imbalances are beginning to surface, suggesting that the cycle may be reaching a critical phase, especially with regard to direct lending to businesses.
Investing in private assets isn't inherently bad, but the problem arises when the compensation for not having immediate liquidity ceases to be attractive. In the direct lending sector, the illiquidity premium has shrunk just as refinancing risks and a lack of transparency in valuations have skyrocketed, leaving investors in a rather precarious position.
The danger of loans without strict guarantees
One of the most troubling trends is the rise of so-called "covenant-lite" loans . These are essentially loans with very lax financial restrictions that replace strict controls with default clauses. This leaves lenders with a very clouded view of the company's true financial health, which, in layman's terms, means they are lending money blindly in many cases.
This lack of transparency has been reflected in recent, high-profile cases. For example, the collapse of Tricolor Holdings, a company specializing in subprime auto loans, revealed that the same collateral may have been used to back multiple loans —a move that reeks of fraud and triggered a plunge in its asset-backed securities (ABS). This was not an isolated case, as First Brands Group also went bankrupt after growth fueled by debt-financed acquisitions that it could not sustain.
The problem is that the non-bank lending market has grown so much that today almost half of new corporate loans come from hedge funds or private equity firms, moving away from the regulatory control that traditional banks have and affecting the impact of private companies on the economy.
The Perfect Storm: Interest Rates and Artificial Intelligence
The sector has hit a wall: the European Central Bank's interest rate hikes . Many funds raised huge amounts of capital in 2021, but as financing costs rose, many deals turned out to be overvalued . Now, investors are trying to recoup their money, but they're finding that the funds are "semi-liquid," meaning they're limiting capital outflows to avoid a massive sell-off of assets at bargain prices.
To this must be added the disruptive effect of artificial intelligence . Private capital invested heavily in software companies over the last decade, but AI is changing the rules of the game so rapidly that many of these businesses have lost value. Experts indicate that more than half of private lending transactions in the last ten years could be affected by this technological factor.
- Vulnerable sectors: Small and medium-sized enterprises exposed to energy costs and tariff pressures.
- Payment strategies: Increased payments in kind (PIK), which is basically postponing the problem of interest payments.
- Assets at risk: Software companies, wealth managers, and insurance brokerages.
Are we facing a systemic crisis similar to 2008?
This is where opinions diverge. Some executives at giants like Blackstone argue that there is no connection to the 2008 crisis because private credit is much less leveraged and investors are professionals who know what they're getting into. For them, the current difficulties are simply market adjustments and not a threat to global stability.
However, regulators and the Bank of England see warning signs. They are concerned about the fragmentation of loans and how risky assets are being repackaged, dangerously reminiscent of subprime mortgages. There are fears that if the insurance sector—which has invested heavily in these assets to provide returns for pensioners—does not have sufficient reserves, the blow could spread to the real economy.
Despite everything, there are ways out. Some strategies, such as asset-based financing (ABF) or senior commercial real estate debt, appear more resilient, as they have tangible collateral and are not as dependent on companies' operating profits.
The current scenario reveals a market in full transition where nominal profitability has taken a backseat to the strength of the balance sheet and the quality of collateral . Although traditional banks have maintained a cautious stance and tightened their criteria, the interconnection with private funds remains the weak point that could trigger a chain reaction if defaults become widespread and liquidity disappears completely.