Top European finance chiefs warn of ‘casino’ behavior in private credit
Heads of European financial institutions are warning of risks in the rapidly growing, multi-trillion-dollar private credit market, with one executive saying parts of it resemble a “casino.” Oliver Bate, chief executive of Allianz , one of the world’s largest insurers, told CNBC that “uncontrolled” growth in the private credit space — which faces much less regulation than traditional banks — raises concerns about a potential repeat of the systemic failures seen during the 2008 financial crisis. “We’re talking about private lending like this is an innovation,” Bate said. “We used to have reasons [for] why we wanted to have banks that are regulated to lend to people, right?” “Now we’re talking about a casino that’s supposedly something that’s called innovative,” Bate added. The head of the German insurance giant was taking aim at private credit firms that are now increasingly borrowing large parts of their funds from banks. The increased leverage helps such funds generate equity-like returns with debt-like financing structures for their investors. Bate said traditional lenders like banks are regulated “because they make sure consumers are protected, [and] that if there’s a crisis, there’s enough equity capital” to absorb losses and prevent a contagion. “Many of these structures don’t,” Bate added. Allianz, with 1.9 trillion euros ($2.3 trillion) under management, also operates in the private credit and private assets sector through its subsidiaries, including Allianz Global Investors and bond fund manager PIMCO. Growth in private credit The global private lending market has tripled in size over the past decade to $1.8 trillion, as small and medium-sized businesses searched for more competitive interest rates on their loans. Insurers and pension funds have also poured money into the asset class in search of higher returns. However, Bate cautioned that the underlying risk appears to be opaque. “Nobody understands where, ultimately, the holders of the risk are,” he said, drawing a direct parallel to the pre-2008 crisis mortgage market. “We will have an event one day, and then the question is, will the system hold?” Some of Bate’s concerns are reflected in data showing signs of stress across the corporates turning to this form of borrowing. Nearly 30% of these mid-sized companies are facing some form of financial stress, according to ratings agency Morningstar DBRS. While the annualized default rate exceeded 2.2% in July with a rising trend, the number of these corporates operating under some form of debt relief has grown to nearly 10%, according to Morningstar DBRS. For these struggling firms, average earnings have plummeted by more than 25%. “Private credit defaults are now occurring at the highest rate since we began keeping records of private credit actions in 2019 as an expanding array of borrowers is facing the combined pressures of slower earnings growth and persistent high borrowing costs on cash flow,” said Morningstar DBRS analysts led by Michael Dimler and Anke Rindermann in a July note. If a systemic issue were to occur, and there was a widespread default among SMEs, the effects would be felt up the lending chain — ultimately hitting the banks that have lent to the private credit funds. “My personal opinion: This is unprofessional to let it happen as it happens, and we all know how populations have reacted after 2008 and [2009],” Bate added. Regulatory gaps Bate is not alone with his caution. Jérôme Grivet, the deputy CEO of French banking giant Credit Agricole , echoed the concerns about a two-tiered financial system. “It’s clear that lending has been developing in banks and also outside banks, with a level of regulation, a level of control, which is not the same,” Grivet said. “So of course, we are worried about that.” He expressed concern about potential contagion, saying: “We want to avoid any difficulty impacting the financial system globally, but coming from outside the banks.” This risk of spillovers has potentially risen, as in the U.S., banks’ total loans to the sector and other non-bank lenders have ballooned to $1.2 trillion, up from just $56 billion in 2010. Forced by competition and driven by profit Despite the warnings, the attractiveness of higher returns remains powerful, particularly for insurers and pension managers facing long-term liabilities. The added yield on private credit can often exceed that of traditional corporate bonds by 100 basis points or more, according to Moody’s. Driven by competition, Crédit Agricole is also now active in the private credit sector through its asset management and insurance subsidiaries. “There is a lot of competition to finance the corporates for their investments,” Grivet added. “So, we try to gather all these elements in order to continue to accelerate the growth of the group.” In the U.K., insurance executives are also viewing private assets as investment destinations. “It is important to invest in private assets,” said Amanda Blanc, CEO of Aviva . She said that relying solely on safe, low-return investments will not be enough for the millions of Britons who are not saving enough for retirement. This view is shared by Antonio Simoes, CEO of Legal and General . “What I see with clients is that they no longer think of public and private markets as separate. Those are really merging,” he told CNBC. A Moody’s survey found that the “vast majority” of insurers plan to increase their private credit holdings, seeing the benefits of higher yield and diversification as outweighing the risks of illiquidity and opacity. “We expect insurers with comparatively low exposure, including some large European groups, to increase their allocations the most,” said Moody’s analysts led by Will Keen-Tomlinson in a June note. As for Allianz’s Bate, he said he is not against private lending in principle, but rather the lack of safeguards. “I think uncontrolled private lending without proper risk management is not what we should allow to happen,” he said.
