Dark Credit

Credit risk been muted despite historically high interest rates in part due to the rapid growth of private credit.

While higher interest rates would suggest greater risk of default, credit spreads have remained low and around pre-pandemic levels. This has partially blunted the restrictiveness of policy despite multi-decade high interest rates.

Part of the reason for the resilience of credit is to be due to investors focusing on the absolute level of rates rather than the narrow spreads. But another reason appears to be the rise of private credit that has kept lending available. Private credit refers to direct lending to businesses by non-bank institutions, usually financed by long term capital from by institutional investors.

Private credit has blunted the impact of tightening impact of monetary policy by actively lending to a wide range of businesses.

Research suggests private credit has grown by both competing with public debt offerings and by willing to offer credit to companies who have difficulty borrowing from banks. The rate hiking cycle has been a boom to private credit because their loans tend to be made on a floating rate basis. Investors have poured hundreds of billions into private credit funds where returns have been strong as higher interest rates off-set higher default rates.

Borrowers find private credit attractive due to their quick execution and bespoke loan terms. Private equity borrowers in particular have been fond of private credit where middle market LBO loans are increasingly dominated by direct lending. The surge in private lending helped fill the void created by the decline in bank lending.

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