Illustration: Aïda Amer/Axios
Private equity has long claimed that it doesn't pose systemic risk to the U.S. or global economies. And so far that's been true.
But, but, but: Credit ratings agency Moody's thinks that positive paradigm might be shifting, per a new report on private credit.
- It's a fear that's also been hinted at by the FDIC chair, which wants more visibility and oversight of private credit, although neither is yet hitting the panic button.
Behind the scenes: Private equity has based its belief on standard structures whereby portfolio companies are siloed.
- If one portfolio company fails, it doesn't impact another — even if within the same fund.
What to know: Moody's believes that the number of leveraged buyouts will soon increase, with better credits heading to the syndicated loan market where economies of scale allow for cheaper pricing. Weaker companies are more apt to stick with private credit, where intense competition among lenders flush with dry powder will lead to laxer terms.
- Meanwhile, the growing glut of private lenders is masking the sector's consolidation "in a smaller group of larger-scale managers," many of whom also have private equity arms and are either buying or partnering with insurance companies.
- Moreover, these firms are increasingly sourcing capital from individual investors (including efforts to expand beyond high-net-worth and into retail).
Per Moody's: "All of this is contributing to the development of an ever-expanding, interrelated lending and investing loop...
- "Another emerging risk is maturity transformation, often a key transmission mechanism for systemic contagion because it can lead to fire sales that then spread to other asset classes ... But it will be difficult to see where risk bubbles may be building, especially since these asset managers are increasingly lending to and borrowing through buying and selling. If one of these large managers were hit with a serious liquidity problem, it would likely spark far more severe credit repercussions in the broader economy."
The big picture: Private equity qua private equity isn't at issue here. Instead, Moody's argues that the industry has gotten too close to lenders that once were more at arm's length, and then a few more arms via syndication.
The bottom line: Predicting the next economic catastrophe has been Wall Street's favorite parlor game since 2008, and the crystal balls typically prove to be cracked.
- For now, the Moody's warning may fuel calls for further regulation of private credit, particularly in terms of transparency. But, longer term, it could cause private equity investors to be a bit more circumspect when championing their industry's macro safety.