Private Credit Risk Likely to Increase: Moody’s

Leverage levels in private credit are likely to rise as alternative asset managers gain a larger portion of the private credit pie, according to a report.

Alternative managers will expand their own origination capabilities, increasing their market share. However, these instruments will raise not just leverage levels, but also concentration risks in financial markets, according to Moody’s Investor Services’ latest research report: “Escalating private credit competition will increase risk and scrutiny.”

“Leverage will increase in a number of ways that may not be immediately visible or obvious because many of these instruments are already commonly used for a range of financing needs,” said Rory Callagy, an associate managing director with Moody’s private credit team.

Moody’s also found that companies are “eager to pocket big interest cost savings” of, in many cases, 200 to 300 basis points by refinancing $8.3 billion of debt to claw back $16 billion of loans that were repaid in favor of private credit in 2023.

Most of the activity so far has been refinancings, noted the report, with overall deal activity totaling $90 billion globally and $80 billion for the US, exceeding the 2023 total for this time.

Competition will only heat up if interest rates fall, putting pressure on private credit returns, particularly the hefty illiquidity premiums that direct lenders already charge. All of this will result in increased convergence between banks and nonbanks, at least for larger transactions.

“We expect LBO activity to gain more traction as private credit lenders put a pile of dry powder to work in the markets to take advantage of cheaper borrowing costs,” added Christina Padgett, head of private credit research at Moody’s Investor Services.