The Bank of Japan has released a report highlighting the expansion and diversification of private credit (PC) funds, particularly in the United States. The core strategy of PC funds involves raising long-term capital from institutional investors and providing direct lending to medium-sized and small companies with lower creditworthiness. However, recent years have seen intensified competition among funds engaged in corporate lending, leading some to change their lending conditions. PC funds are diversifying in both asset types and structures, with asset-based finance (ABF) funds and semi-liquid funds targeted at retail investors growing in popularity. This shift suggests a change in the risk profiles of some PC funds.
The report notes that the private credit market has grown significantly, with the total outstanding pool of assets eligible for asset-based finance estimated to be around $5.5 trillion to $6.1 trillion. ABF funds offer a premium of roughly 200-250 basis points compared to asset-backed securities. The report also highlights the increasing interconnectedness between PC funds, banks, insurance companies, and other financial institutions, which could lead to a larger impact of credit deterioration in the portfolio companies of PC funds.
The Bank of Japan emphasizes the need to closely monitor the PC market, particularly in light of the increasing use of payment-in-kind (PIK) loans and the relaxation of lending standards. The report also notes that default rates of private credit borrowers are low but show an upward trend when using broader measures. The Bank of Japan suggests that PC funds can serve as a provider of long-term risk capital, but it is essential to maintain a distinction between the roles of banks and non-banks in this regard.
In Japan, domestic institutional investors, including banks, life insurers, and pension funds, are expanding their exposure to PC as part of their alternative asset investments. The Bank of Japan stresses the importance of accurately identifying structural changes in the overseas market and the sources of risk, including the risks associated with underlying assets of ABF funds, liquidity risks in semi-liquid funds, and sector concentration risks.
Key statistics from the report include:
* The total outstanding pool of assets eligible for asset-based finance is estimated to be around $5.5 trillion to $6.1 trillion.
* ABF funds offer a premium of roughly 200-250 basis points compared to asset-backed securities.
* Default rates of private credit borrowers are low but show an upward trend when using broader measures.
* The private credit market has grown significantly, with PC funds diversifying in both asset types and structures.
The report concludes that the expansion and diversification of PC funds require close monitoring, particularly in light of the increasing interconnectedness between PC funds, banks, insurance companies, and other financial institutions. The Bank of Japan emphasizes the importance of maintaining a distinction between the roles of banks and non-banks in providing long-term risk capital.