The Bank of England (BoE) this week reiterated its concerns about the risks of higher interest rates and limited data disclosure in private credit markets. Harvey Schwartz, CEO of The Carlyle Group with some 380 billion dollars under management, believes those concerns are exaggerated.
Lee Foulger, BoE’s Director of Financial Stability and Risk, highlighted that higher interest rates, weaker economic growth, and tighter lending conditions could cause problems for non-banking companies, especially in the private credit market. “Previous stresses have shown how business model risks can build up and interact with system-wide vulnerabilities in a way that can affect lending to households and businesses and impact systemically important institutions and markets when conditions deteriorate,” Foulger said at a conference in London on Monday.
Harvey Schwartz, the CEO of alternative asset manager The Carlyle Group, called those fears around private credit - the main asset class for Carlyle - more media hype than reality. “It’s not a rational approach,” Schwartz remarked a day later at a conference in Miami.
Schwartz emphasised that Carlyle is not engaged in these risky spheres. “Our leverage is low, our commitment structure is excellent, and we have no concentrated positions or interconnections. I think some of these discussions about shadow banking are a bit exaggerated and misunderstood.”
Precise assessment of risks remains tricky
The BoE argues that the floating rate structure of private credit agreements is vulnerable to issues around debt repayment and refinancing in a higher interest rate environment. Despite the tougher macroeconomic environment, parties active in the private credit market report low default rates. “Highly funded borrowers have seen a significant drop in their interest coverage ratios over the past year,” Foulger noted.
According to the BoE, “amend-and-extend” practices are becoming more common, with lenders agreeing to defer the maturity of a loan, often in exchange for higher yields and tighter financial controls. “Payment-in-kind” practices, where borrowers with low liquidity issue new debt to meet interest payments, are also on the rise, the central bank stated.
Foulger remarked, “It is difficult to determine exactly how big these risks are or when they really become a problem. It is challenging to get reliable data to closely monitor the risks in the private credit market.”
‘Concerns are exaggerated’
Given the floating rates of liabilities, the prospect of interest rate cuts by the Fed in 2024 is a welcome development for borrower capacity in the direct credit market. However, Schwartz speaks out against the extreme desire for interest rate cuts.
“I know there is some kind of general market desire for, say, six or eight cuts,” Schwartz commented. “I think that’s a bad wish, because normalising the cost of capital - if we can navigate this and make modest cuts - would be really good.”
Nevertheless, Carlyle is undoubtedly affected by higher interest rates. The alternative asset manager reported a 43% drop in distributable profits in the third quarter of last year compared to a year earlier, as fewer deals were completed than in previous quarters.
Asset managers up in arms
This is not the first time an alternative asset manager has reacted sharply to comments about risks in the private credit market.
In November, during a speech at a financial conference in Hong Kong, Colm Kelleher, Chairman of UBS, predicted that the next financial crisis would occur in private credit. Kelleher mentioned he made these remarks “at the risk of upsetting half the people in the room, including clients and competitors.”
Marc Rowan, CEO of alternative asset manager Apollo, defended the quality of the private credit market at the same event. He asserted that Apollo possessed “huge amounts of liquidity” and that he could “barely get the ink off his fingerprints” due to extensive correspondence with regulators and supervisors.