Moody's Sounds Alarm on "Private Credit" Boom, Warns of Bank Run Echoes

Moody's, the prominent credit rating agency, has raised concerns about a potential build-up of risk in the US credit market, fuelled by a surge of funds from everyday investors into the rapidly expanding realm of "private credit" since the Covid-19 pandemic.

As reported by Reuters, the agency issued a warning on Wednesday regarding the heightened risks associated with retail investors allocating their capital to "private credit" assets, a trend that could have repercussions for the American economy.

Since the onset of the global health crisis, the landscape of credit provision in the United States and across the globe has seen a gradual shift away from traditional banks towards "private credit firms".

These entities have experienced significant growth, now managing assets exceeding $2 trillion since their inception in 2014, according to Moody's report.

This expansion has occurred even against a backdrop of market volatility, including the period following former President's imposition of import tariffs on China and other nations.

"Despite persistent market turbulence, alternative asset managers continue to launch funds aimed at attracting retail investors to 'private credit' and other private assets," Moody's analysts stated in their Wednesday briefing.
 

The increasing involvement of smaller investors in the burgeoning private credit market has accelerated since the pandemic's onset, largely driven by the emergence of evergreen open-ended funds.

These funds are designed for continuous and sustainable long-term growth and, unlike traditional closed-end funds, do not have a fixed lifespan.

Furthermore, exchange-traded funds (ETFs) focusing on private credit investments have also gained traction. Moody's highlighted that the growing popularity of these ETFs could redefine accessibility to private markets, albeit with a crucial need for robust protective mechanisms.

The credit rating agency pointed out that both ETFs and evergreen funds targeting retail investors offer considerably more flexibility regarding the inflow and outflow of investment capital compared to their closed-end counterparts.

Moody's analysts drew a parallel between this liquidity freedom and the risks associated with rapid withdrawals from banks – a scenario experienced by Silicon Valley Bank and other regional lenders in the preceding year.
 

This potential mismatch between the liquidity terms offered by the funds and the expectations of investors could undermine confidence in the fund sponsors themselves.

In addition, Moody's flagged risks stemming from less stringent regulations or limitations governing lenders and borrowers within the loan agreements of evergreen funds when compared to those of closed-end funds.

"Retail investor capital can significantly expand private markets, but managing liquidity and building transparency will be critical to long-term success," Moody's concluded.