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Opinion Private credit
Private credit acts as a cycle dampener rather than an amplifier
by Randy Schwimmer
Randy Schwimmer
Vice chairman
Churchill Asset Management
Direct lending definitely won’t cause a new financial crisis — and it may mitigate its effecs
According to Merriam-Webster, ‘apophenia’ is “the tendency to perceive a connection or meaningful pattern between unrelated or random things”. Leveraged loans and CLOs were blamed for the GFC, for example, because of their rapid growth, complexity and proximity to the banking system. Today, these features put a bullseye on private credit. But the evidence tells a different story.
Systemic crises share two defining features: size large enough to matter and direct linkages capable of transmitting losses across the financial system. Private credit — including BDCs — has USD 1.3tn in total assets deployed. That sounds significant, but both the leveraged loan and high yield bond markets are larger, valued at USD 1.5tn each. Direct lending represents only 3% of total US household and business debt. At the GFC peak, mortgages accounted for 60%. By that measure, private credit is a rounding error.
Consider linkages. Bank exposure to private credit (“back leverage”) stands at USD 300bn. But that is only 1.5% of total bank assets, compared to almost 14% for subprime loans in 2008. Given loan advance rates are 70-75%, losses well above historic highs would be necessary for a bank’s loan book to be impaired.
Private credit works as a backstop
Comparisons with 2008 overlook the fact that direct lending serves as a release valve for public credit. When BSL spreads widen, borrowers migrate to private credit. This played out in 2022 and 2023, when the Fed’s rate hikes and bank failures closed the BSL and bond markets for business. Private credit filled the void.
Private credit holds significant advantages over bank loans. It is more conservatively structured, with financial covenants. Buy-and-hold managers are equipped to work patiently with stressed credits to preserve value. Overall, these structural advantages allow the asset class to act as a cycle dampener rather than an amplifier.
Are we late in the credit cycle? Multiple speed bumps — COVID, bank failures, tariffs, rate shocks — have failed to derail the economy for long. Clearly, central bank intervention at every liquidity crunch has been a major factor. But we believe private credit has played a significant role.
A recent academic paper argued that despite concerns “private credit could amplify credit supply shocks, our results indicate that private credit may dampen the corporate credit cycle. [This has] important implications for assessing the financial stability ramifications of the rapid growth in private credit.”
Has the cycle been calmed? Direct lending has rewired how credit is being accessed, managed and absorbed by the financial system. It serves as the lender of last resort for middle market firms when the broadly syndicated loan market shuts down. Consolidation and regulation pushed banks from storing leveraged loans to moving them to CLOs and retail funds. If those buyers were risk-off, public markets closed. Financing channels were open because private capital had raised ample dry powder from long-term institutional investors. Corporate issuers could finance growth and operations through macro headwinds.
Banks carry 10 times more leverage
Overlooked is that, even with strengthened Tier-1 capital, banks carry significantly more balance sheet leverage — at about 10x versus non-banks. BDCs, for example, are subject to a statutory leverage limit of 2x debt-to-equity, but tend to operate well below that limit and closer to 1x.
One of the hallmarks of past crises is ‘flighty’ capital. But direct lenders match their assets with long-term liabilities anchored by experienced capital providers with long investment horizons. Banks, by contrast, fund themselves with deposits and short-term borrowings — the very definition of duration mismatch.
Retail redemptions ticked up this year, but gates exist to prevent destabilising runs and to protect investors who stay the course. Meanwhile, insurance companies, pension plans and sovereign wealth funds are not just supporting private allocations, they are expanding them.
None of this means blame games will cease, or the credit cycle is dead. Rates, inflation and growth still matter. But core middle market lending has been fully functioning in all weathers for decades, delivering consistent premium yields to investors. Its success invites media scrutiny, as well as a narrative that private credit is the next systemic fault line. The truth is that, when the next sustained recession comes, private credit could well be a major reason why that downturn proves less damaging than the last.
