A systemic threat?
Since banks are increasingly providing credit lines to non-bank lenders, the findings that switching to PIK interest is potentially a hidden default pose questions about contagion risk. However, the research suggests that this is unlikely.
First, “only around 15% of loans held by BDCs end up using PIKs”, says Rintamäki. Second, his research finds that activating the PIK toggle increases the risk of a loan becoming delinquent in the next quarter by two to three percentage points. This starts from a low base of nonaccruals (3%) and affects the lenders themselves, as opposed to banks.
Third, the research examines bank credit lines to BDCs. It finds that the potential transmission risk is low, since more than 90% of bank credit lines explicitly restrict PIK collateral. This forces PIK-heavy BDCs to reduce
their lending activity rather than increase their own indebtedness.
BDCs are well suited to individual investors who can’t tolerate the illiquidity of a pure PE position.
David Robinson, Duke University
Meanwhile, Robinson and Wallskog examine how regulators should approach private credit. They suggest that the focus on systemic risk may be incomplete: it ignores the fact that many private credit firms are substantially different from banks and so may not respond to a “one-size-fits-all banking-style regulatory framework”.
To test this, the authors study a regulatory shock in 2018 that loosened leverage limits for BDCs. They find that BDCs that behave more like banks expanded more than those making investments more akin to PE. They also suggest that any private credit vulnerabilities are more likely to affect
individuals, since these investors increasingly fund the market.
A final question is whether BDC data accurately represent the broader private credit market. Robinson and Wallskog acknowledge that they study BDCs – rather than the broader private credit market – because that’s where they have access to data. “We are clearly looking for keys under the streetlight,” says Robinson.
For Miller, research into BDCs provides some insights into the private credit market more generally. “There are differences, but rigorous analysis of this segment is certainly valuable,” he says. While BDCs differ from private credit funds, he adds, “the findings are often directionally correct”.
It remains to be seen how the features, protections and regulatory considerations explored in the research ultimately play out. But one thing does seem certain: with no sign of the negative headlines abating any time soon, private credit is just going to have to get used to being in the spotlight.
