Investment giants spent their quarterly earnings calls this fall defending their private-credit investments amid spreading concerns about the hidden risks of the ballooning asset class.
Such concerns exploded when the bankruptcy of First Brands, a heavily indebted auto parts supplier, led to steep losses for some lenders.
“We do not view the events that have unfolded for those companies as canaries in the coal mine for the health of the private credit markets,” said Marc Lipschultz of Blue Owl Capital, which had nearly $150 billion in private credit assets under management as of the end of June. Lipschultz emphasized that Blue Owl had no exposure to First Brands.
Private credit has ballooned over the last several years as investors have sought yield amid a higher interest rate environment and a tightening IPO market that crimped private equity returns. The market for nonbank lending grew to $3 trillion by the start of the year, up from $2 trillion in 2020. The worry is that the fierce competition for deals and the mountains of dry powder may tempt lenders to relax their standards.
Impact investors have also piled into private credit, an important source of non-dilutive capital to support growth, such as the building of factories or expansion into new markets.
About half of impact investors responding to The GIIN’s 2024 survey were pursuing private debt strategies. Phenix Capital counts 423 private debt impact funds. Impact private credit is a broad market spanning sustainable infrastructure, real estate, affordable housing, renewable energy projects, healthcare and small business loans in the US and abroad.
A general withdrawal by institutional investors, of course, could hurt impact private credit providers as well.
“It’s already hard to sell an impact-focused thesis to typically skeptical institutional investors; it certainly won’t be easier if their reference point for the overall asset class is negative,” impact investment advisor Antony Bugg-Levine told ImpactAlpha. “They may not be discerning about the ways in which the best impact private credit providers manage financial risk.”
Firms such as Ares Management, Apollo Global Management and Blackstone have raked in cash for multi-billion dollar debt funds, taking business from less flexible banks. Big pension funds and insurance companies have been allocating more to the asset class. And high net worth Americans are getting into the game, pouring $48 billion into private credit funds in the first half of this year. Soon, such investments could be open to retirement savers as well.
In the spirit of ‘If you can’t beat ‘em, join ‘em,’ banks lent billions to fund their private lending rivals’ war chests.
“From my point of view, credit is credit, whether it’s originated by a bank or an asset manager,” Marc Rowan of Apollo Global Management told analysts. “It makes almost no difference to me. There are fundamentally good underwriters of credit, and there are less good underwriters of credit.” Apollo reported $723 billion in private credit assets under management in the third quarter.
Unlike banks, private investment firms are largely unregulated even as they increasingly underwrite loans to businesses, private equity firms and AI data center buildouts. Even that distinction begins to blur, however, as banks increasingly fund the balance sheets of their private-lender competitors.
Debt bubble
The debt fest has reached almost absurd heights, most notably in data centers, which are increasingly funded via off-the-books debt deals rather than from balance sheet cash.
Last month, Blue Owl Capital partnered with Meta to finance its $27 billion dollar Hyperion data center in Louisiana. Blue Owl Capital will own 80% of the joint venture, with Meta retaining the remainder. Blue Owl in turn raised debt from PIMCO and other bond investors to finance the deal. Meta will make lease payments to the joint venture.
The deal reflects the growing complexity and interconnectedness of private loans, especially related to the massive spending on artificial intelligence. The AI and data center buildout was responsible for as much as 92% of GDP growth in the first half of the year, according to Harvard economist Jason Furman.
AI potentially could transform the economy and usher in scientific and medical breakthroughs; it may even help cut energy use by making it more efficient. But overall, it has demonstrated little real benefit so far. Most corporate executives in a recent McKinsey survey reported no impact from generative AI on their bottom lines.
The economic reliance on the sector has begun to spook the broader market. If the AI bubble bursts, as many are predicting, that would send seismic waves throughout the industry. And that’s not to mention the real concerns about runaway development of AI and the prospect of general intelligence that could quickly slip out of our control.
The private credit market may be flashing the first signs of broader distress, even as the Trump administration loosens regulations put in place after the financial crisis of 2008.
“There’s clearly a private debt bubble,” says Robert Brown of Impact Evaluation Lab. “There are risks that are not being priced in.”
Financial chiefs argue that First Brands and other recent credit blowups are examples of idiosyncratic risk, not a systemic problem (JPMorgan’s Jamie Dimon’s comment that “When you see one cockroach, there are probably more,” notwithstanding). But the worries are mounting.
“What is very important in these situations is to consider the second- and third-order risks exposure of other smaller banks or hedge funds that we may be dealing with,” Pam Kaur of British bank HSBC said on the bank’s recent earnings call last week.
Impact credit
Overextended finances, sloppy oversight and outright fraud can sink impact firms as well — see Bitwise, Aspiration, and All Here, for example. But some in the field say that many impact-focused lenders are safer given their smaller loan sizes, lack of syndication, and high-touch approach.
In many cases, “Impact credit providers take more time to get to know their borrowers and are more committed to their long-term success, not just their ability to service debt until the next private equity sale,” said Bugg-Levine.
“The regular realities of good investing don’t get suspended for impact investors,” he said. “Private credit providers who have been thoughtful in their underwriting, have not increased leverage or reduced covenant requirements, and have invested in resilient businesses that can generate profit through the full economic cycle should do relatively well.”
Bugg-Levine points to Apis & Heritage, which lends to businesses making the transition to employee ownership, as an example of private debt done right.
“I’d hold up their insight into their borrowers’ business, the trust they establish, and the thoughtfulness they apply to deal sourcing and diligence against any of the massive private credit providers like the ones caught up in the First Brands bankruptcy,” he said.
The bigger risk: impact lenders and their portfolio companies are likely to be among the most harmed by the Trump administration’s erratic policies, at least in the US.
Tariffs are driving up costs, electricity prices are surging and unemployment is on the upswing. Cuts to Medicaid and food assistance are scrambling livelihoods and business models. That will hit lower-income communities the hardest.
Allianz Global Investors, which has raised some €705 million ($809 million) for an impact private credit strategy launched last year, is watching the situation closely. Its strategy focuses on European small- to mid-cap companies that generally have less exposure to the US, said the firm’s Alexandra Tixier.
The asset manager is not changing its allocation to the asset class, for now, said Tixier. But “we acknowledge the necessity for heightened caution and selectivity in constructing our portfolio during these times, especially because this is difficult to assess the potential indirect-indirect impact even on a very local business model. Consequently, we have deliberately declined some opportunities where the impact was favorable, but the credit was considered too weak, especially given the current economic environment.”
Several other impact credit funds that ImpactAlpha reached out to were unavailable or declined to comment. But the economic fallout can be seen at the low end of the market, particularly in underserved areas in the US.
Loan losses
Take community development financial institutions, or CDFIs. The mission-driven lenders operate in underserved and low-income communities where banks are absent, making loans to households, businesses and developers that might otherwise not be able to access financing. They have been supported by federal funding and policies – many of which are at risk under the Trump administration.
Despite lending to what might be considered risky borrowers, CDFIs have historically experienced very low defaults, on par with major banks — in part because they know their borrowers well, providing technical assistance and working with them when they hit rough patches. But at the Opportunity Finance network conference in Washington, DC last month, CDFI lenders spoke of signs of portfolio distress.
CDFIs are on high alert, scrutinizing loans and even laying off staff. Business Impact NW, a CDFI that lends to small businesses in the Pacific Northwest, has seen loan defaults tick up to 2% from a more typical 1%. ‘We’re seeing a spike in our losses,” shared the nonprofit’s Joe Sky-Tucker.
“Our investors are nervous,” said Tim Martin of Enterprise Community Loan Fund, a housing and construction lender. “I’ve probably been on four or five investor calls within the last 45 days.”
He said Enterprise is looking closely at its loans that are maturing in the next 90 days to see where they stand, and reaching out to developers to see if they need loan extensions. To soothe investors, Martin said, the best strategy is “knowing our deals.”
Medicaid cuts are impacting revenue projections for lenders to community health center development projects. And with some 42 million Americans affected by a shutdown disruption of the Supplemental Nutrition Assistance Program, or SNAP, grocers in low-income neighborhoods are feeling the pinch.
Tonitrice Wicks with Winrock International, a business assistance nonprofit, pointed to a grocery store she works with in a rural, low-income area that stands to lose 60% of its revenues if SNAP benefits lapse. “There is fear there,” she said.
Indeed, Brown of Impact Evaluation Lab, speculates that impact investors “may have more damage” than the broader market.
A counter-argument could be made that impact investors generally are not involved in large syndicated loans that could come crashing down if the AI bubble bursts. A broader crash could put to the test de-risking tools and models honed over the decades, such as loan guarantees and loan loss reserves.
Perhaps the best defense for impact private credit funds came, albeit unwittingly, from Apollo’s Rowan, who noted the difference between “agents” and “principals.” Principals underwrite risks they are prepared to hold. Agents underwrite risks they think they can distribute, he said.
“Sometimes it doesn’t matter, but when things are priced for perfection, we believe it matters more than ever.”
ImpactAlpha correspondent Danielle Rossingh contributed reporting from London.
