On 6 December, the Bank of England’s Financial Policy Committee (FPC) published its biannual Financial Stability Report, which identifies the private credit and leveraged lending markets as “particularly vulnerable” to higher interest rates. The Report warns that the overall risk environment remains challenging and, echoing an October 2023 report, states that vulnerabilities in parts of market-based finance remain significant and have increased, highlighting the following key risks:

• Interconnectedness and opacity;
• Leverage, and maturity and liquidity mismatch;
• Contingent risk.

On private credit, the Report highlights the rapid growth of the market and the dependence of “vulnerable businesses” on private credit funding.  It also recognises that private credit defaults remain low, but warns that the market has seen a sharp fall in interest coverage ratios.  It also highlights that private credit can present risks to UK financial stability through issues like forced sales, wider market disruption, and tighter credit conditions.  The Report also adds that:

• There is limited data available on the maturity profile of outstanding private credit loans;
• There could be refinancing risks in the future, but ‘amend and extend’ agreements have become popular in private credit as an innovative approach to manage interest rate risk and delay the maturity wall;
• Private credit exposures are increasingly being securitised into CLOs;

On hedge funds, the Report shows concerns over hedge fund net short positioning in US Treasury futures and their use of borrowing through the repo market, which altogether can amplify market stress.

For further information, please contact Guillermo Pérez Molina, Private Credit Associate.