There are “disasters waiting to happen” in private lending due to looser lending standards and the huge amount of capital that has flooded the sector, the chief investment officer of one of the world’s biggest charities has warned.
Nick Moakes of the £37.6bn Wellcome Trust told the Financial Times that large investors in such funds could suffer “very significant” losses if the US economy eventually falls into recession.
“If the world gets a little tougher economically, I think there are some accidents waiting to happen in the private lending world,” Moakes said in an interview.
“If there’s a problem within that whole ecosystem, there are going to be some very prominent investors, many of whom have some kind of systemic importance, who are going to be pretty damaged,” he added.
His comments come after ratings agency KBRA warned against it on Tuesday private loan borrowers who have struggled to repay their debts could finally “face the music” this year, as higher-than-expected interest rates weigh on corporate balance sheets.
The firm, which analyzes large parts of the private lending market, said most loans would be repaid without issue, but borrowers whose “business models or capital structures have not adapted to the higher-interest environment” could start defaulting on their debt. .
As traditional banks pulled back from lending after the 2008 financial crisis, private loans, which finance a wide range of areas such as corporate acquisitions and consumer loans, have grown rapidly.
But a growing chorus of central bankers, policymakers and some of Wall Street’s top officials — including JPMorgan Chase CEO Jamie Dimon — flagged potential problems.
Moakes said that while private credit is “less risky” systemically than bank financing because leverage levels are lower, private equity managers have been able to borrow large amounts of money with minimal checks and balances.
“As [the private credit market has] became popular, it sucked up a huge amount of capital. This meant that the lending standards applied in certain parts of the private credit markets were lowered,” he said.
“It’s great for private equity borrowers,” he said. But for investors, “if you see a slower economy, especially if you end up with a recession in the US, which we will one day . . . there will be some hairstyles [losses] which should be taken, and could be very significant.”
KBRA estimates that the default rate in the private loan market will jump to 3 percent in 2025, up from 1.9 percent at the end of last year.
That forecast was fueled in part by a rapid turnaround in markets since Donald Trump was elected the 47th US president in November, with investors betting that the Federal Reserve will not be able to cut interest rates as much as previously expected.
“With the pace of rate cuts expected to slow, companies at the bottom of our credit rating distribution could face a reckoning in 2025,” said KBRA analysts John Sage and William Cox.
Moakes also pointed to the increasing power and reach of large, diversified U.S.-listed alternative investment managers and said their massive growth may not benefit core fund investors.
“There are a number of very large asset management companies that have been created, and all the power is at their fingertips,” Moakes said.
“They’re great companies and they’ll have a private equity arm, they’ll have a private lending arm, and they’ll probably have a hedge fund arm and a real estate arm. . . and [their funds] they lend to each other,” he added. “It’s all a bit circular.”
Moakes said that as alternative firms have gone public, they face greater pressure to increase assets under management to maximize management fees, which may not be in the best interest of generating investment performance.
As this space attracted more and more capital, the expected yield should, logically, have fallen, he said.
“The risks are growing. . . You can construct all kinds of cataclysmic scenarios where they destroy each other, but really, they won’t, because what they did is very clever. All these things are in the LP [fund] vehicles. Therefore, all the responsibility is on the investors.”
The Welcome trustfounded in 1936 after the death of pharmaceutical entrepreneur Henry Wellcome, it exists today with the mission of funding scientific research in the field of mental health; infectious diseases; and climate and health.
It doesn’t invest directly in private credit, but it does have a window into the industry because about a third of its portfolio is allocated to private equity.
Moakes, who will retire from the Wellcome Trust at the end of March, was speaking as the trust reported results for the 12 months to 30 September. The trust gained 15.6 per cent in US dollars, although in sterling the return was 5.2 per cent due to the pound’s strength.
He also reported spending £1.6 billion on scientific research for charitable purposes. Over the past 10 years it has been 11.3 cents a year in pounds.
