The abrupt failure last autumn of several American firms supported by private credit has brought a rapidly expanding and murky segment of market lending into focus. Private credit, often referred to as direct lending, encompasses lending activities conducted by nonbank institutions. The practice has existed for decades but experienced a significant increase in popularity following the regulatory changes after the 2008 financial crisis, which deterred banks from catering to riskier borrowers. The projected growth — from $3.4 trillion in 2025 to an estimated $4.9 trillion by 2029 — alongside the September bankruptcies of auto-industry firms Tricolor and First Brands, has prompted certain notable figures on market to express concerns regarding this asset class. Jamie Dimon cautioned in October that issues in credit are seldom singular: “When you see one cockroach, there are probably more.” Billionaire bond investor Jeffrey Gundlach, a month later, accused private lenders of making “garbage loans” and predicted that the next financial crisis will originate from private credit. Although concerns regarding private credit have diminished in recent weeks due to the lack of significant bankruptcies or losses reported by banks, they remain partially intact. Firms closely associated with the asset class, including Blue Owl Capital, alongside alternative asset behemoths Blackstone and KKR, continue to trade significantly below their recent peaks. Private credit is characterized as “lightly regulated, less transparent, opaque, and it’s growing really fast, which doesn’t necessarily mean there’s a problem in the financial system, but it is a necessary condition for one,” according to Mark Zandi in an interview. Proponents of private credit, including Apollo co-founder Marc Rowan, argue that the expansion of this sector has significantly contributed to American economic growth by addressing the void created by traditional banks, providing investors with attractive returns, and enhancing the overall resilience of the financial system.

Large institutional investors, such as pension funds and insurance companies that manage long-term liabilities, are perceived as more reliable sources of capital for multiyear corporate loans compared to banks that rely on short-term deposits, which can be volatile, according to private credit operators. Concerns regarding private credit, often voiced by competitors in the public debt sector, are indeed justifiable considering its characteristics. Ultimately, it is the asset managers engaged in private credit lending who are responsible for valuing these loans, and they may have incentives to postpone acknowledging any issues that borrowers may face. According to Duke Law professor Elisabeth de Fontenay, the phenomenon referred to as “the double-edged sword of private credit” highlights that lenders possess “really strong incentives to monitor for problems.” She stated “But by the same token … they do in fact have incentives to try to disguise risk, if they think or hope that there might be some way out of it down the road.” De Fontenay, who has examined the effects of private equity and debt on corporate America, expressed her primary concern regarding the challenges in determining whether private lenders are accurately valuing their loans. “This market is exceptionally vast and increasingly engaging a wider array of businesses, yet it remains a non-public market,” she stated. “There is some uncertainty regarding the accuracy of the valuations.” In the November collapse of home improvement firm Renovo, BlackRock and other private lenders assessed its debt as being valued at 100 cents on the dollar until just prior to adjusting it to zero.

According to a report, defaults on private loans are anticipated to increase this year, particularly as indications of strain among borrowers with lower creditworthiness become evident. Private credit borrowers are increasingly utilizing payment-in-kind options to delay defaults on loans, as reported. Ironically, despite being competitors, a portion of the private credit boom has been financed by the banks themselves. Following the disclosures of losses related to the auto industry bankruptcies in the fall by investment bank Jefferies, JPMorgan, and Fifth Third, investors became aware of the magnitude of this lending practice. Last year, bank loans to non-depository financial institutions, or NDFIs, amounted to $1.14 trillion, according to the Federal Reserve Bank of St. Louis. On January 13, JPMorgan revealed its lending to nonbank financial firms for the first time during its fourth-quarter earnings presentation. The category experienced a threefold increase, reaching approximately $160 billion in loans by 2025, up from around $50 billion in 2018. Banks are now “back in the game” as deregulation under the Trump administration is set to liberate capital, enabling them to broaden their lending activities, according to Moody’s Zandi. He indicated that this, along with the emergence of newer players in private credit, could result in diminished loan underwriting standards.

“There is a significant increase in competition for similar lending opportunities,” Zandi stated. “If history serves as a reference, that raises a concern … as it likely suggests a deterioration in underwriting standards and, in the end, more significant credit issues in the future.” Although Zandi and de Fontenay did not indicate an impending collapse in the sector, the ongoing expansion of private credit will undoubtedly enhance its significance within the U.S. financial system. When banks encounter turbulence due to the loans they have issued, there exists a well-defined regulatory playbook. However, de Fontenay suggests that future challenges in the private sector may prove more difficult to address. “It raises broader questions from the perspective of the safety and soundness of the overall system,” de Fontenay stated. “Will we possess sufficient knowledge to identify potential issues before they manifest?”