S&P warns on US insurers’ growing bet on private credit

Rating agency S&P has warned of risks from the complexity and lack of disclosure in the private credit market, as US insurers push into the fast-growing asset class.

“There’s just a lot less transparency” about private credit assets, said Carmi Margalit, S&P’s head of North American life insurance.

The agency estimates that $530bn, or about 23 per cent, of life insurers’ corporate bond holdings were issued through private placements, rather than public offerings.

Of these, about $218bn had a “private letter” credit rating, confidential scores available only to the issuer and some investors. 

The private credit market provides trillions of dollars of loans to companies. It took off after the 2008 financial crisis, when stricter regulations forced banks to tighten their lending standards.

The US life insurance industry, which has more than $8tn of invested assets and manages retirement savings for millions of people, has been among the biggest investors.

The industry’s private credit holdings also include $71bn of structured finance bonds with private letter ratings, according to S&P.

Since they have obligations that stretch decades into the future, life insurers are better suited than other institutions, such as property insurers or banks, to holding illiquid assets.

But the push into private credit has loaded insurers’ balance sheets with complex assets, including collateralised loan obligations and loans with custom terms, which S&P said would require close monitoring.

“To understand what’s going on in a middle market CLO, you have to understand the loans in the underlying collateral, what kind of credit stress could hit those individual loans . . . what’s the industry and geographical distribution? What’s the structure of the CLO itself, and how does stress in the underlying assets actually manifest itself in . . . the individual tranche that you own? And that’s a relatively straightforward example,” Margalit told the Financial Times.

Structured securities help insurers reduce the capital they would need if they held loans to middle-market companies and other products directly.

S&P found that, in part because of its illiquidity and complexity, private credit had delivered up to 2 percentage points in additional yield for insurers compared with similarly rated public bonds.

Private equity firms helped spur the industry’s move into private assets, with groups such as Apollo Global Management and Blackstone buying or striking deals with life insurers over the past decade.

One insurance asset manager said he had expected the rush into private credit to subside after the pandemic, as rising interest rates increased yields on publicly traded corporate bonds.

But he found it increasingly difficult to compete with private equity-backed insurers without exposure to complex products that delivered marginally higher returns.

“I literally had an insurance company say to me: ‘If we can get 10 extra basis points of illiquidity premium or complexity premium over public, we want it’,” he said. “That’s when I realised, OK, this is not going to go away.”