Private Debt Looks Shaky to a Wall Street on Recession Alert
Private Debt Looks Shaky to a Wall Street on Recession Alert
(Bloomberg) -- Snowballing recession fears are shining a light on corners of the market hiding the heaviest debt loads.
To Morgan Stanley Investment Management, private debt is the weakest link in the global credit chain. Pimco warns the asset class, along with leveraged lending and high-yield bonds, is among the most exposed to a cyclical downturn if the coronavirus puts large swaths of the workforce on lockdown.
For small companies that are vulnerable to supply chain chaos and which rely on private-debt financing, a looming downturn might be even worse.
“If we start to have cracks in the credit area, if that becomes very very stressed and we can’t transmit credit to the real economy or this creates a bigger problem for some of the weaker companies that can’t refinance, that becomes more systemic,” Jim Caron, fixed-income portfolio manager at Morgan Stanley Investment Management, said in an interview with Bloomberg TV this week.
Traders in stocks and credit put the risks of a recession at about 30% in the next 12 months while Treasuries imply odds as high as 95%. That’s more than before the Federal Reserve’s emergency rate cut Tuesday, according to JPMorgan Chase & Co. research.
Pimco just raised its U.S. recession probability to about 35% from 25% in the next 24 months. It said the Fed’s move to grease the wheels of credit only goes so far. During an economic wobble in 2019, when GDP growth decelerated to 2% from 3%, “private credit lending activity ground to a halt,” the firm pointed out in a recent outlook.
“Large areas of the corporate private credit market are especially vulnerable to a general deterioration in economic growth,” Pimco managers wrote in a note this week. Alongside leveraged loans and junk bonds, private markets “hold large concentrations of debt in sectors that are highly cyclical,” they said.
Not everyone sees danger brewing. JPMorgan Asset Management has been pouncing on alternative investments like private credit to beef up returns as central banks worldwide embark on a new rate-cutting cycle. UBS Global Wealth Management recommends investing in private-equity funds that target distressed companies suffering from the havoc created by the virus.
Private debt has mushroomed, gobbled up by pension funds struggling to meet return targets and ready to fill the void of banks that have retreated from smaller, unrated borrowers in the wake of the financial crisis. Assets tied up in private and bilateral loans reached around $800 billion at the end of last year, more than twice their volume a decade earlier, according to Preqin.
The question that Caron and others are asking now is how deeply a pullback in the world of shadow lending would cut through to the wider economy.
“When we start to think about credit even in the more smaller private-sector parts of credit -- this is more of the smaller and mid-sized businesses -- these are the guys that really need to roll over their debt. And they don’t call Jamie Dimon and say ‘hey, I need a new loan’,” he said. “That is the lifeblood of the American economy.”
--With assistance from Rachel McGovern, Kelsey Butler and John Gittelsohn.
To contact the reporter on this story: Cecile Gutscher in London at cgutscher@bloomberg.net
To contact the editors responsible for this story: Sam Potter at spotter33@bloomberg.net, Sid Verma
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