„We're out“, says the insider, on the condition that neither he nor his company are named. The man with the anonymous voice is a ripped-off Swiss investment professional who has learnt a thing or two in his more than 30 years in the business: Never expose yourself without high financial gain. The field that the discreet gentleman wants to leave to the competition after years of lucrative business is called „private debt“.

These capital markets are by no means as private as the term suggests. The money that mainly smaller companies borrow on these markets largely belongs to the general public – the people whose savings are in pension funds or life insurance policies. However, very few of them realise that they are invested there. In the world of pension provision based on the division of labour, a reference to the total return in the annual statement of assets is the maximum amount of information available to most insured persons.

The decisions are made by investment specialists. Specialists who, unlike ordinary savers, have „qualified investor“ authorisation from the authorities. In other words, they know the particular risks of the hidden capital and financial markets, and know how best to protect capital there.

But how good are these qualified investment specialists really? How carefully do they handle savers' capital? Not carefully enough, the insider believes, saying that "private debt has far too much money.“ He believes that there are too many investors in these hidden debt markets. They are prepared to take risks with other people's savings for which there is no longer an appropriate return. Historically, the risk of corporate loans in the private market has been compensated with an annual return of 5% to 7% plus a reference interest rate. These yield levels have not been reached for some time.

The International Monetary Fund (IMF), whose tasks include monitoring global financial stability, explains how this can become a problem for large and small savers. In April, the institution warned in its annual stability report that private debt is an „opaque“ market in which slightly built borrowers are financing themselves to an ever greater extent via capital from pension funds and insurance companies. If this market remains so opaque, its exponential growth continues, and its limited monitoring is not expanded, it could pose a risk to financial stability, the report states.

Warning is indeed a core function of the IMF. However, the concerns of the authority in Washington are by no means far-fetched. The credit volume on the hidden capital markets has exploded since the financial crisis in 2007. It currently amounts to around 2 trillion dollars, and has multiplied many times over in the past 16 or 17 years.

Bank regulation and low interest rates are driving growth. In the wake of the financial crisis, regulators forced banks to back their loans with more equity. Although this measure curbed their appetite for risk, it also opened the door to business with non-publicly tradable equity and debt securities (private equity and private debt) to a far less strictly regulated brokerage sector. It is an immense segment. Blackstone and Apollo, two of the largest players on the global private markets, with assets under management of 1 trillion and 500 billion dollars respectively, estimate the potential for private debt alone at 30 to 40 trillion dollars.

The second reason for the high growth rates is the dramatic fall in interest rates. Since the financial crisis, low interest rates have fuelled investors' hunt for investment opportunities with better yield prospects. Insurance companies and pension funds, which have to fulfill fixed performance promises to their customers, are particularly receptive to such offers.

For Jürg Lutz, founder and managing director of the pension fund consultancy PK Assets, it is clear that the dangerous bubble that the IMF is warning about has already been created. „The bubble will continue to grow until it is burst by a recession or another event", says the experienced bond market analyst. „That can take a long time in some circumstances.“ However, it is clear that the bursting of financial bubbles leads to the destruction of assets that only existed on paper.

The IMF writes that the risk cannot be measured precisely, due to the poor data situation in the private markets. However, Jürg Lutz and the cautious „insider“ now recognise the alarming signs, some of which have already been mentioned in the stability report, all too clearly.

Both refer to the worrying increase in so-called covenant-lite agreements. These are loan agreements in which the conditions serving to secure the creditors are greatly watered down. Even active players such as Andrew Bellis, Head of Division at the large Swiss private debt broker and private market specialist Partners Group, recently said in an interview with the trade journal Private Debt Investor that "we are seeing an increase in covenant-lite contracts.“ There is a concern that private capital brokers are overstretching themselves in their intense competition for lucrative deals.

Partners Group, Blackstone, Apollo and many other players have their clients pay high management and performance fees for their brokerage work. They pay without question in the expectation of reaping high returns. But what looks like a win-win situation at the moment could quickly turn out to be the opposite.

„Private debt is a seller's market,“ says Lutz. „The conditions are now set by the debtors and no longer by the lenders.“ This inversion of the economic world is all the more worrying because in many cases the borrowers have hardly any collateral to offer.

Since 2022, when rising inflation rates led to a global increase in interest rates, many have found themselves in distress. Nevertheless, there has not been a drastic increase in insolvencies. One reason for this is that defaulting interest payments are increasingly no longer being claimed via the insolvency office. Instead, outstanding payment obligations are added to the debt and only claimed when the loan falls due. „Payment-in-Kind“ (PIK) is the elegant method used to prevent bankruptcies and maintain the illusion of stability.

According to a Bloomberg survey, there are currently almost twice as many private debt contracts with PIK clauses as at the end of 2021. Just as alarming is another trend: Certain banks are now trying to structure private credit portfolios in such a way that they can also be sold as ETFs via the stock exchange to ordinary, non-qualified investors. This definitely reduces „private debt“ to absurdity. The hidden capital markets become public again via the back door, with the difference that the debtors in the hidden markets do not have to fulfil any transparency and information requirements to protect their creditors.