There is very limited access to secondary trading in private credit. Given the direct exposure to creditors, this might present a liquidity bottleneck for investors if credit conditions deteriorate.
If a fund investing in public assets saw a similar situation it could start to trade out of its positions in order to maintain the credit quality its mandate had set. A private lender cannot.
However, there are good reasons this should not present major risks to the wider system, and even to the investors.
Private assets typically lack a public rating. Credit funds usually rate underlying assets privately, giving them a ‘shadow rating’. Their valuation is often conducted quarterly, with two to three month lags on the data itself, due to the complexity of gathering that information relative to public markets. That model prevents the assets being prices in a timely manner consistent with typical secondary market trading.
“Borrowers tend to be small to medium-sized companies, with average EBITDAs of US$30-40 million and 5-7x debt to EBITDA ratios – comparable to single B through CCC borrowers in public markets,” according to Morgan Stanley Research. “Yields are typically over 150bps higher than single B loans, with higher annualised returns and lower volatility. This makes Private Credit an attractive alternative to public fixed income markets for asset owners looking to match longer-term liability durations.”
It is common for illiquid assets to be packaged into more liquid instruments via securitisation. This has helped to bridge the gap between the illiquid and more liquid parts of the market, by creating containers that can be traded as securitised instruments.
The syndicated loan market is an example of this, and collateralised loan obligations (CLOs), or exchange traded funds (ETFs) are wrappers that support the buying and selling of less liquid asset in a more liquid market.
In private credit, the current lag in valuation and the lack of transparency in ratings are too non-standard and challenging to allow a private credit ETF or CLO to be developed.
“I think there are just structural features of the underlying asset class that perhaps will need to be overcome before we get there [in private credit],” said Putri Pascualy, senior MD & client portfolio manager at Man Varagon, speaking at the firm’s ‘Credit Outlook 2025’ event in December. “There is a secondary market in fund shares, including for less liquid assets like private equity. But that market has features of illiquid assets.”
Although the growth in private credit is strong, Morgan Stanley’s recent report, ‘Extending Credit: The Evolving Role of Wholesale Banks in Credit Markets’ found that the “risks associated with the higher allocation to private credit appear manageable.”
There is a likely to be spread compression where floating rate debt has been issued thanks to falling rates over the next year. Although the report also notes that private credit tends to be lower rated than most public credit which has improved transparency, liquidity, and credit quality the bank assesses this risk as manageable. With single lender exposure, a lack of leverage and typically well assessed loan terms despite the liquidity bottleneck that exists, consensus is that risks within private credit are currently limited, even absent a secondary market.
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