Credit cockroaches revisited

Good morning. The University of Michigan consumer sentiment index came out on Friday and the numbers were horrible. But as we have observed before, indices of sentiment have been sliding south for years now, and coming apart from hard measures such as consumer spending and business activity. Does sentiment matter to markets any more? Send us your thoughts: unhedged@ft.com. 

Cockroaches revisited

First Brands’ problems started appearing in the FT’s pages a little over two months ago, and Tricolor not long thereafter. A few smaller fraudulent or semi-fraudulent credit crack-ups dribbled out next. Everyone immediately started asking whether this was a coincidental cluster of idiosyncratic events, or the bleeding edge of a downturn in the credit cycle. 

The question was most often pointed at the private credit industry. This may have been a bit unfair, given that many of the loans involved were bank loans or traded “144a” loans — not exactly public but not truly private, either. In any case, since these questions were put to private credit, we’ve had an earnings reporting season, during which asset managers and business development companies that specialise in private credit responded. Their message has been clear and, as far as I know, unanimous: there are no signs that the credit cycle is turning. 

Here is Michael Arougheti, the CEO of Ares Management:

These events appear to be idiosyncratic and isolated and not the sign of a turn in the credit cycle. From our vantage point, our credit portfolios also remain healthy, and we’ve not seen any deterioration in credit fundamentals or changes in amendment activity that would indicate a turn in the cycle is coming . . . we continue to see healthy year-over-year double-digit Ebitda growth across our US direct lending strategies

And here is Marc Lipschultz, CEO of Blue Owl Capital:

Broadly speaking, we do not view the events that have unfolded for those companies as canaries in the coal mine for the health of the private credit markets…

The health of our credit portfolio remains excellent with an average annual realised loss of just 13 basis points and no signs of meaningful stress. In direct lending, the modest level of non-accruals we have seen are not thematic in nature…

Finally, here is Marc Rowan of Apollo:

From my point of view, credit is credit, whether it’s originated by a bank or an asset manager. It makes almost no difference to me. There are fundamentally good underwriters of credit and there are less good underwriters of credit. The observed outcome of the number of articles and the focus on a couple of isolated incidents in the marketplace is nil. Ten basis points of spread widening is essentially nothing.

I think that — and here I am knowingly making myself hostage to fortune — these comments are not only true, but probably representative of the private credit industry. Look at the backdrop: the macroeconomy is mostly solid, corporate earnings are very good, public bond performance is good, households and company balance sheets are sound. Loans should be performing well, and the cockroaches probably are idiosyncratic.

What we need to be worried about is not, however, what is happening now. The private credit industry has grown very quickly in the past few years. Its growth has been limited, as Rowan recently put it, only by its “capacity to find good investments, rather than by its capacity to raise capital.” We have discovered, even before the macroeconomy has shown any broad signs of weakness, that competition for assets has driven a few lenders beyond the limits of basic prudence. What happens if the economy should falter? 

An important bank chart to squint at and get frustrated

In the last month or two Unhedged has spent some time pointing out that the fastest-growing category of US bank lending is lending to shadow banks; complaining that the “Call Report” disclosures about such loans are vague and inadequate; and noting that, in the context of recent reports of fraudulent bank lending (see above) the key class of loan to think about is warehouse lending.  

Into this amorphous cloud of observations and worries comes sailing the Federal Reserve’s 2025 Financial Stability Report (FSR), out just last week. It devotes 104 words and two graphs to the topic of “Bank lending to other financial entities”. The words amount to “this stuff is growing quickly, and there are several different kinds of it.” The first chart is tantalising, but quite frustrating: 

What is tantalising is that the Fed’s 10-part categorisation of loans to non-bank financial institutions, which come from a set of bank disclosures called “Form FR Y-14Q,” is more fine-grained than the five category disclosure from banks’ Call Reports (the five categories are “business, mortgage, private equity, consumer credit, other”). What is frustrating is that the FSR chart is small and only lets you ballpark the size and growth rate of each category. And no, you can’t go back to the FR Y-14Qs and get the hard numbers for yourself, because they are not public.

Dear Fed: free the FR Y-14Qs!

The second FSR chart only helps a little bit, by giving growth rates for each category over the past 12 months, both in terms of lending commitments and lending:

Loans to “financial transactions processing” companies are growing fast but it’s a very small category. The big grower is loans into structured securities: special purpose entities, collateralised loan obligations, and asset-backed securities. To generalise, these are the vehicles through which syndicated loans, mortgages, and consumer loans are packaged up for institutional consumption. And my assumption is that almost all the lending here is warehouse lending: that is, giving the packagers short-term money to buy the assets to build the security before it is sold to investors. (Of course it is possible that banks are putting long-term money into structured products, as many did pre-great financial crisis, to monstrous effect; but let us all say a little prayer and assume that’s not happening). 

So, all of you next-financial-crisis Cassandras, here is a nice target for your pronouncements: banks once again get left holding the bag when a wave of structured products goes wrong. If Unhedged had to guess, we’d say this was unlikely to happen, but it’s an area to watch and to ask banks about. 

Another large and fast growing loan category, on both the Call Reports and the FR Y-14Qs: “Other.” What’s in that bucket? We don’t know.  

About that Challenger report 

Several readers wrote in to give their views of the Challenger lay-off report, which showed such an ugly trend in October. The consensus among our correspondents was that the report just doesn’t tell you very much. Jake Meyer, US economist at Barings, sums up:

Challenger only tracks the portion of lay-offs that are large enough and/or at firms large enough to be included in WARN notices [a mass lay-off disclosure required by law], firm press releases, or media coverage . . . the large majority of actual lay-offs aren’t captured in Challenger and there’s no reason to think the subset that are is closely representative of the wider market

Here is Meyer’s chart comparing Challenger to official US lay-off figures. Note the vast difference in scale for the two measures:

One good read

The basis trade as a US geopolitical vulnerability.

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