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Private Credit’s Second Act Raises Some Eyebrows

Private equity’s foray into asset-based finance is fueling concerns over hidden debt and concentration risk.

(Bloomberg Opinion) -- In the last two years, private credit has blossomed, along with the Federal Reserve’s rate hikes and banks’ retreat from risky lending. But as conditions for its outsize success unwind and the broadly syndicated loan market reopens, non-traditional lenders are looking for a second act. 

Asset-based finance is the new catch phrase. This type of lending is supported by cash flows from, say, credit card receivables or aircraft leasing, and is historically the domain of banks. Currently, private credit manages about $1.7 trillion. But the universe will be much broader if we include ABF, which KKR & Co. Inc. estimates to be about $5.2 trillion

Already, private equity giants are making inroads. In February, Barclays Plc sold about $1.1 billion worth of credit card debt to Blackstone Inc.’s credit and insurance division. In December, a group led by KKR purchased a roughly $7.2 billion portfolio of recreational vehicle loans from Canada’s Bank of Montreal. In both cases, the banks will continue to service the accounts. 

This is a familiar plot, where alternative managers step in while banks retreat. In Barclays’ case, its US credit card loan book faces extra capital requirements imposed by the UK regulators. As a result, the British lender has to sell existing debt to continue growing its overseas business. This opens a window for private equity houses, which are barely regulated. Rather than putting all risks on their balance sheets, banks could keep half, while offloading the rest to alternative asset managers, Blackstone President Jonathan Gray told the Financial Times last May. 

As their bread-and-butter buyout business slows, private equity giants are seeking new ways to fundraise and earn handsome fees. Insurance companies are the natural cash cows to milk. The three kings of private equity — Apollo Global Management Inc., Blackstone and KKR — have all bought insurers or taken minority stakes in them in exchange for managing their assets. 

Blackstone’s credit and insurance division manages about $319 billion, or around 30% of its total assets. The metrics at Apollo are even more extreme. After completing a merger with insurer Athene in 2022, Apollo generated more net income last year than it did over the previous decade. More than 80% of the firm’s assets under management are in credit. Spread-related earnings, or the money it made from investing policyholders’ premiums, reached $3.1 billion, accounting for over 60% of the firm’s total profit. 

Originating private credit assets to sell to its Athene annuities business is crucial for Apollo’s growth, Chief Executive Officer Marc Rowan has said. ABFs, in turn, come in handy, because they often boast investment-grade credit ratings. Insurers tend to prefer high-quality assets and shy away from junk-rated corporate debt. 

But alternative managers’ foray into the likes of auto loans and credit card debt is raising eyebrows. In a March report, Moody’s Investors Service spelled out two issues. ABFs are opaque securitized instruments to start with. The involvement of private credit funds can build additional hidden leverage, especially if managers are allowed to enhance their returns with borrowings. But more importantly, the agency is concerned about concentration risk, where a few large private equity houses are responsible for a fast-evolving financial ecosystem and thus have an outsize influence in the economy.

Ultimately, tight banking regulations have fueled much of the increased private credit activity. By now, the three kings alone oversee more than $2 trillion, bigger than the US junk bond or leveraged loan markets. As they spread deeper into everyday life, why are they still not being regulated? They are the real hidden whales, not banks. 

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To contact the author of this story:
Shuli Ren at [email protected]

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