Opaque Private Credit Industry Threatens Heavy Debt Burdens, Systemic Risk
By Andrew Park
Problems are brewing in a scheme that is bigger than the Australian economy and almost completely without federal oversight. It is called private credit — large scale lending, but not by banks — and has surged from less than $300 billion in loans in 2013 to over $2.1 trillion globally today. This unregulated market has become yet another tool for the private equity industry to pursue leveraged buyouts and leaves target companies on the hook to repay the new mountains of debt. If this large pool of unregulated loans go sour, the distress could spread into the broader financial system, including traditional banks, and pose systemic risk to the financial system.
Private credit, sometimes referred to as non-bank direct lending, refers to entities affiliated with hedge funds or private equity firms who extend loans to corporations. This lending practice mirrors loans from megabanks such as J.P. Morgan or Goldman Sachs. Regulators, including the Federal Reserve, Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), can peer into bank loan books. There is currently no regulatory agency, including the Securities and Exchange Commission, that has full visibility into or responsibility for the private credit market.
The exponential growth in the private credit market is mostly fueling leveraged buyouts and corporate refinance loans that are coming due (sort of like refinancing a mortgage). These loans do not go to help invest in new capacity or hire more workers, unlike most traditional business loans by banks. Instead, the private credit lenders are mostly trying to collect fees on the new loans they make. According to the private equity firm The Carlyle Group, private credit has allowed leveraged buyouts and refinancings to continue across the industry even as the Federal Reserve raised interest rates through the end of 2023. At one point in 2023, the private credit market financed 94 percent of buyouts by numbers and 70 percent by volume.
Traditional banks are also entering this new business to capture a share of the profits that private equity firms are vacuuming up by using their relationships with customers to lend out money in the private credit space. Banks, including Goldman Sachs, JPMorgan Chase, and Wells Fargo, have all sought to tap the private credit bonanza. For example, Citigroup struck up a 5-year partnership with Apollo Global Management to place up to $25 billion in private credit loans.
Private credit funds have pumped billions into shakey leveraged buyouts. In 2021, private equity firm Vista Equity Partners’ bought the education technology company Pluralsight for $3.5 billion. Instead of banks providing loans to finance Vista Equity’s leveraged buyout, a number of non-bank private credit funds such as BlackRock, Ares Management, and Oaktree Capital provided a $1.7 billion loan — about half the cost of the takeover.
Since Pluralsight was not yet a profitable company, those private credit lenders extended the loans on outlandish terms based on how quickly they believed revenues could grow, a very risky proposition for a company that suddenly had to service interest payments on the $1.7 billion debt that financed the buyout.
Fast forward to 2024, when the company’s revenue growth projections failed to keep up with what lenders were hoping for in 2021.
The private equity owner Vista Equity then resorted to a financial maneuver to extract value out of the company before it collapsed, similar to what other private equity owners did with J. Crew, Neiman Marcus, and other companies in recent years. Vista created a new shell company, transferred the assets of Pluralsight into the shell, and extended a new loan to the shell company. The new loan put Vista’s repayment claims ahead of those of its other private credit lenders, who previously stood to be paid back first.
Aggressive private credit lending often ends poorly for all. Vista Equity Partners has written off its $1.8 billion equity stake in Pluralsight and is preparing to hand over control to these private credit lenders. Pluralsight and its employees have not been able to grow their company after its buyout, instead succumbing to the massive debt burden, and it appears to be teetering on the verge of bankruptcy, unable to repay its debts.
All of these transactions occurred in the shadows, outside the purview of regulators and largely opaque even to the market. Private credit loans may have initially generated lucrative fees for its lenders, but since private credit is not actively traded (and not traded at all on public markets, like corporate bonds), it is difficult to know what the loans are really worth. Some of the lenders have marked down the Pluralsight debt. At the end of March 2024, these private credit debt markets now value it as low as 80 cents on the dollar, though some have marked it down only to 97 cents on the dollar. It’s possible those values have fallen even further since then.
There is increasing concern that risky private credit loans could seep into other financial institutions that could be exposed to private credit as co-investors. We know very little about the growing business between traditional banks and private credit, other than — to borrow the words of Bloomberg News — it is a “frenzy.”
The private credit market is still relatively small compared to the size of the subprime mortgage market or the derivatives exposure leading up to the 2008 financial crisis, but the emerging risks in the private credit market and other highly indebted corporate borrowers could be disastrous. Private equity-owned firms, such as Pluralsight, can be far more likely to collapse into bankruptcy from the unsustainable debt burdens once Wall Street has taken over. Now, the private credit loans that back these perilous deals and their interconnectedness with traditional banks are a growing and unknown risk to the financial system that warrants close monitoring.
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